UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

 

Commission file number 1-15885

 

 

 

BRUSH ENGINEERED MATERIALS INC.

(Exact name of Registrant as specified in its charter)

 

 

 

Registrant’s telephone number, including area code 216-486-4200

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:

None

 

Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Act.  Yes o     No þ

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No þ

 

The aggregate market value of Common Stock, no par value, held by non-affiliates of the registrant (based upon the closing sale price on the New York Stock Exchange) on June 27, 2008 was $521,755,594.

 

As of February 13, 2009, there were 20,108,960 common shares, no par value, outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the proxy statement for the annual meeting of shareholders to be held on May 6, 2009 are incorporated by reference into Part III.

 

 

BRUSH ENGINEERED MATERIALS INC.

 

Index to Annual Report
On Form 10-K for
Year Ended December 31, 2008

 

 

 

Forward-Looking Statements

 

Portions of the narrative set forth in this document that are not statements of historical or current facts are forward-looking statements. Our actual future performance may materially differ from that contemplated by the forward-looking statements as a result of a variety of factors. These factors include, in addition to those mentioned elsewhere herein:

 

 

 

Brush Engineered Materials Inc., through its wholly owned subsidiaries, is a manufacturer of high performance advanced enabling engineered materials serving the global telecommunications and computer, data storage, aerospace and defense, automotive electronics, industrial components, appliance and medical markets. As of December 31, 2008, we had 2,235 employees.

 

Our businesses are organized under four reportable segments: Advanced Material Technologies and Services (AMTS), Specialty Engineered Alloys (SEA), Beryllium and Beryllium Composites and Engineered Material Systems. AMTS consists of Williams Advanced Materials Inc. (WAM). SEA consists of Alloy Products, which includes bulk and strip form products, and beryllium hydroxide produced by Brush Resources Inc. (BRI). The

Beryllium and Beryllium Composites segment consists of Beryllium Products and Brush Ceramic Products Inc. while the Engineered Material Systems segment consists of Technical Materials, Inc. (TMI).

 

Our parent company, Brush Engineered Materials Inc., and other corporate expenses, as well as the operating results from BEM Services, Inc., Zentrix Technologies Inc. (Zentrix) and Circuits Processing Technology, Inc. (CPT), all wholly owned subsidiaries, are not part of any segment and remain in All Other. BEM Services, Inc. charges a management fee for the services it provides, primarily corporate, administrative and financial oversight, to our other businesses on a cost-plus basis. Zentrix manufactures electronic packages and other components for sale to the telecommunications and computer and automotive electronics markets, and CPT manufactured circuitry for defense and commercial applications. CPT was sold in March of 2007. Corporate employees not covered as part of a reportable segment, including employees of BEM Services, Inc. and Zentrix, totaled 149 as of December 31, 2008.

 

Our website address is www.beminc.com. Information contained on our website does not constitute part of this Form 10-K. We make available, free of charge through our website, our Annual Report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, as well as amendments to those reports, as soon as reasonably practicable after we file such reports with, or furnish such reports to, the Securities and Exchange Commission.

 

ADVANCED MATERIAL TECHNOLOGIES AND SERVICES

 

AMTS is comprised of WAM. Sales for this segment were $466.4 million or 51% of total sales in 2008, $519.9 million or 54% of total sales in 2007 and $343.4 million or 45% of total sales in 2006. As of December 31, 2008, AMTS had 743 employees.

 

AMTS manufactures and fabricates precious, non-precious and specialty metal products for the data storage, medical and the wireless, photonics, semiconductor and hybrid segments of the microelectronics market. AMTS also has refining capabilities for the reclaim of precious and non-precious metals from internally or customer-generated scrap. In addition, AMTS provides chamber services for its customers to reclaim precious metals and refurbish reusable components used in its customers’ vapor deposition systems. AMTS’ major product lines include vapor deposition targets, clad and precious metals preforms, high temperature braze materials, ultra fine wire, sealing lids for the semiconductor/hybrid markets and specialty inorganic materials. In February 2008, AMTS purchased the assets of Techni-Met, Inc. based in Windsor, Connecticut, which supplies a wide range of high end applications for advanced technology industries, including supporting downstream customers in developing more accurate diagnostic devices for diabetes management.

 

AMTS’ products are sold directly from its facilities in Buffalo, New York; Brewster, New York; Wheatfield, New York; Buellton, California; Milwaukee, Wisconsin; Windsor, Connecticut; Santa Clara, California; Ireland; Singapore; Taiwan; Japan; Korea; the Philippines; China and the Czech Republic, as well as through direct sales offices and independent sales representatives throughout the world. Principal competition includes companies such as Sumitomo Metals, Heraeus Inc., Praxair, Inc., Honeywell International Inc., Solar Applied Materials Technology Corp. and a number of smaller regional and national suppliers.

 

Advanced Material Technologies and Services — Sales and Backlog

 

The backlog of unshipped orders for AMTS as of December 31, 2008, 2007 and 2006 was $31.0 million, $23.8 million and $28.7 million, respectively. Backlog is generally represented by purchase orders that may be terminated under certain conditions. We expect that substantially all of our backlog of orders for this segment at December 31, 2008 will be filled during 2009.

 

Sales are made to over 2,800 customers. Government sales, principally subcontracts, accounted for less than 1% of the sales volume in 2008, 2007 and 2006. Sales outside the United States, principally to Europe and Asia, accounted for approximately 24% of sales in 2008, 30% of sales in 2007 and 18% of sales in 2006. Other segment reporting and geographic information is contained in Note M of Notes to Consolidated Financial Statements, which can be found in Part II, Item 8 of this Form 10-K and which is incorporated herein by reference.

Advanced Material Technologies and Services — Research and Development

 

Active research and development programs seek new product compositions and designs as well as process innovations. Expenditures for research and development for AMTS amounted to $2.4 million in 2008, $1.6 million in 2007 and $0.4 million in 2006. A staff of 19 scientists, engineers and technicians was employed in this effort as of year-end 2008.

 

SPECIALTY ENGINEERED ALLOYS

 

SEA sells strip products, bulk products and beryllium hydroxide (BRI). Sales for this segment were $299.9 million or 33% of total sales in 2008, $290.0 million or 30% of total sales in 2007 and $275.6 million, or 36% of total sales in 2006. As of December 31, 2008, SEA had 893 employees.

 

SEA manufactures beryllium-containing and other high performance-based materials including copper-nickel-tin alloys that are metallurgically tailored to meet specific customer performance requirements. These products exhibit high electrical and thermal conductivities, high strength and hardness, good formability, lubricity, and excellent resistance to corrosion, wear and fatigue. These alloys, sold in strip and bulk form, are ideal choices for demanding applications in the telecommunications and computer, aerospace, industrial components (including oil and gas, heavy equipment and plastic mold tooling) and appliance markets. These products are sold domestically through SEA and independent distribution centers and internationally through Company-owned and independent distribution centers and independent sales representatives.

 

SEA’s primary direct competitor in strip form beryllium alloys is NGK Insulators, Ltd. of Nagoya, Japan, with subsidiaries in the United States and Europe. SEA also competes with alloy systems manufactured by Global Brass and Copper, Inc., Wieland Electric, Inc., Stolberger Metallwerke GmbH, Nippon Mining, PMX Industries, Inc. and also with other generally less expensive materials, including phosphor bronze, stainless steel and other specialty copper and nickel alloys which are produced by a variety of companies around the world. In the area of bulk products (bar, plate, tube and rod), in addition to NGK Insulators, SEA competes with several smaller regional producers such as Freedom Alloys in the United States, LaBronze Industriel in Europe and Young II in Asia.

 

SEA, through BRI, manages our mine and milling operations. The milling operations produce beryllium hydroxide from mined bertrandite ore and purchased beryl ore. The beryllium hydroxide is used primarily as a raw material input by the other businesses within the Company. BRI also sells beryllium hydroxide externally to SEA’s primary competitor in beryllium alloys, NGK Insulators, Ltd.

 

Specialty Engineered Alloys — Sales and Backlog

 

The backlog of unshipped orders for SEA as of December 31, 2008, 2007 and 2006 was $55.5 million, $71.5 million and $62.1 million, respectively. Backlog is generally represented by purchase orders that may be terminated under certain conditions. We expect that substantially all the backlog of orders for this segment as of December 31, 2008 will be filled during 2009.

 

Sales are made to over 2,200 customers. SEA had no government sales in 2008, and such sales, principally subcontracts, were less than 1% of segment sales in 2007 and 2006. Sales outside the United States, principally to Europe and Asia, accounted for approximately 57% of sales in 2008 and 55% of sales in 2007 and 2006. Other segment reporting and geographic information is contained in Note M of Notes to Consolidated Financial Statements, which can be found in Part II, Item 8 of this Form 10-K and which is incorporated herein by reference.

 

Specialty Engineered Alloys — Research and Development

 

Active research and development programs seek new product compositions and designs as well as process innovations. Expenditures for research and development amounted to $2.3 million in 2008, $1.9 million in 2007 and $2.1 million in 2006. A staff of eight scientists, engineers and technicians was employed in this effort as of year-end 2008.

BERYLLIUM AND BERYLLIUM COMPOSITES

 

Beryllium and Beryllium Composites includes Beryllium Products and Brush Ceramic Products Inc. Sales for this segment were $63.6 million or 7% of total sales in 2008, $60.5 million or 6% of total sales in 2007 and $57.6 million or 8% of total sales in 2006. As of December 31, 2008, Beryllium and Beryllium Composites had 272 employees.

 

Beryllium and Beryllium Composites manufactures products that include beryllium and AlBeMet^®. Beryllium is a lightweight metal possessing unique mechanical and thermal properties. Its specific stiffness is much greater than other engineered structural materials such as aluminum, titanium and steel. Beryllium is extracted from both bertrandite ore, which is mined by the Company, and imported beryl ore. In June 2008, we announced that Brush Wellman Inc. had entered into an agreement with the Department of Defense to construct a $90.4 million primary beryllium facility. This facility will produce primary beryllium, the feedstock material used to produce beryllium metal products. Construction of this facility is targeted for completion in 2010. Beryllium products are used in a variety of high performance applications in the defense, space, industrial, scientific equipment, electronics (including acoustics), medical, automotive electronics and optical scanning markets. Beryllium-containing products are sold throughout the world through a direct sales organization and through Company-owned and independent distribution centers. While Beryllium and Beryllium Composites is the only domestic producer of metallic beryllium, it competes with other fabricators as well as with designs utilizing other materials.

 

Beryllium and Beryllium Composites also manufactures beryllia ceramics for electronic packaging and electro-optical applications including lasers. Electronic components utilizing beryllia are used in the telecommunications, medical, industrial, automotive and defense markets. These products are distributed through direct sales and independent sales agents. Direct competitors include American Beryllia Inc. and CBL Ceramics Limited.

 

Beryllium and Beryllium Composites — Sales and Backlog

 

The backlog of unshipped orders for Beryllium and Beryllium Composites as of December 31, 2008, 2007 and 2006 was $28.7 million, $23.9 million and $18.4 million, respectively. Backlog is generally represented by purchase orders that may be terminated under certain conditions. We expect that substantially all of our backlog of orders for this segment at December 31, 2008 will be filled during 2009.

 

Sales are made to over 300 customers. Government sales, principally subcontracts, accounted for less than 1% of Beryllium and Beryllium Composites’ sales in 2008, and 1% of segment sales in 2007 and 2006. Sales outside the United States, principally to Europe and Asia, accounted for approximately 23% of sales in 2008, 16% of sales in 2007 and 29% of sales in 2006. Other segment reporting and geographic information is contained in Note M of Notes to Consolidated Financial Statements, which can be found in Part II, Item 8 of this Form 10-K and which is incorporated herein by reference.

 

Beryllium and Beryllium Composites — Research and Development

 

Active research and development programs seek new product compositions and designs as well as process innovations. Expenditures for research and development amounted to $1.3 million in 2008, $1.0 million in 2007 and $1.1 million in 2006. A staff of eight scientists, engineers and technicians was employed in this effort as of year-end 2008. Some research and development projects, expenditures for which are not material, were externally sponsored and funded.

 

ENGINEERED MATERIAL SYSTEMS

 

Engineered Material Systems is comprised of TMI. Sales for this segment were $65.9 million or 7% of total sales in 2008, $70.9 million or 7% of total sales in 2007 and $68.7 million or 9% of total sales in 2006. As of December 31, 2008, Engineered Material Systems had 178 employees.

 

Engineered Material Systems manufactures engineered material systems, which include clad inlay and overlay metals, precious and base metal electroplated systems, electron beam welded systems, contour profiled systems and solder-coated metals systems. These products are used in telecommunications and computer systems, data storage, automotive electronics, semi-conductors, energy, defense and medical applications. Engineered Material Systems’

products are sold directly and through its sales representatives. Engineered Material Systems has limited competition in the United States and several European manufacturers are competitors for the sale of inlay strip.

 

Engineered Material Systems — Sales and Backlog

 

The backlog of unshipped orders for Engineered Material Systems as of December 31, 2008, 2007 and 2006 was $7.6 million, $12.2 million and $16.1 million, respectively. Backlog is generally represented by purchase orders that may be terminated under certain conditions. We expect that substantially all of our backlog of orders for this segment at December 31, 2008 will be filled during 2009.

 

Sales are made to approximately 200 customers. Engineered Material Systems did not have any sales to the government for 2008, 2007 or 2006. Sales outside the United States, principally to Europe and Asia, accounted for approximately 17% of Engineered Material Systems’ sales in 2008, 12% of sales in 2007 and 9% of sales in 2006. Other segment reporting and geographic information is contained in Note M of Notes to Consolidated Financial Statements, which can be found in Part II, Item 8 of this Form 10-K and which is incorporated herein by reference.

 

Engineered Material Systems — Research and Development

 

Active research and development programs seek new product compositions and designs as well as process innovations. Expenditures for research and development for Engineered Material Systems were nominal in 2008, 2007 and 2006.

 

GENERAL

 

Availability of Raw Materials

 

The principal raw materials we use are beryllium (extracted from both imported beryl ore and bertrandite ore mined from our Utah properties), copper, gold, silver, nickel, platinum, palladium, aluminum and ruthenium. A new bertrandite pit has been developed at our Utah mine site and we began extracting ore in early 2008. Ore reserve data can be found in Part II, Item 7 of this Form 10-K. The availability of these raw materials, as well as other materials used by us, is adequate and generally not dependent on any one supplier.

 

Patents and Licenses

 

We own patents, patent applications and licenses relating to certain of our products and processes. While our rights under the patents and licenses are of some importance to our operations, our business is not materially dependent on any one patent or license or on all of our patents and licenses as a group.

 

Regulatory Matters

 

We are subject to a variety of laws which regulate the manufacture, processing, use, handling, storage, transport, treatment, emission, release and disposal of substances and wastes used or generated in manufacturing. For decades we have operated our facilities under applicable standards of inplant and outplant emissions and releases. The inhalation of airborne beryllium particulate may present a health hazard to certain individuals. Standards for exposure to beryllium are under review by the U.S. Occupational Safety and Health Administration (OSHA) and by other governmental and private standard-setting organizations. One result of these reviews will likely be more stringent worker safety standards. Some organizations, such as the California Occupational Health and Safety Administration and the American Conference of Governmental Industrial Hygienists, have adopted standards that are more stringent than the current standards of OSHA. The development, proposal or adoption of more stringent standards may affect buying decisions by the users of beryllium-containing products. If the standards are made more stringent and/or our customers or other downstream users decide to reduce their use of beryllium-containing products, our results of operations, liquidity and financial condition could be materially adversely affected. The impact of this potential adverse effect would depend on the nature and extent of the changes to the standards, the cost and ability to meet the new standards, the extent of any reduction in customer use and other factors. The magnitude of this potential adverse effect cannot be estimated.

Executive Officers of the Registrant

 

 

 

Our business, financial condition, results of operations and cash flows can be affected by a number of factors, including but not limited to those set forth below and elsewhere in this Annual Report on Form 10-K, any one of which could cause our actual results to vary materially from recent results or from our anticipated future results. Therefore, an investment in us involves some risks, including the risks described below. The risks discussed below are not the only risks that we may experience. If any of the following risks occur, our business, results of operations or financial condition could be negatively impacted.

 

Health issues, litigation and government regulation relating to machining and manufacturing of beryllium-containing products could significantly reduce demand for our products, limit our ability to operate and adversely affect our profitability.

 

If exposed to respirable beryllium fumes, dusts or powder, some individuals may demonstrate an allergic reaction to beryllium and may later develop a chronic lung disease known as chronic beryllium disease, or CBD. Some people who are diagnosed with CBD do not develop clinical symptoms at all. In others, the disease can lead to scarring and damage of lung tissue, causing clinical symptoms that include shortness of breath, wheezing and coughing. Severe cases of CBD can cause disability or death.

 

Further, some scientists claim there is evidence of an association between beryllium exposure and lung cancer, and certain standard-setting organizations have classified beryllium and beryllium compounds as human carcinogens.

The health risks relating to exposure to beryllium have been, and will continue to be, a significant issue confronting the beryllium-containing products industry. The health risks associated with beryllium have resulted in product liability claims, employee and third-party lawsuits and increased levels of scrutiny by federal, state, foreign and international regulatory authorities. This scrutiny includes regulatory decisions relating to the approval or prohibition of the use of beryllium-containing material for various uses. Concerns over CBD and other potential adverse health effects relating to beryllium, as well as concerns regarding potential liability from the use of beryllium, may discourage our customers’ use of our beryllium-containing products and significantly reduce demand for our products. In addition, continued or increased adverse media coverage relating to our beryllium-containing products could damage our reputation or cause a decrease in demand for beryllium-containing products, which could adversely affect our profitability.

 

Our bertrandite ore mining and beryllium-related manufacturing operations and some of our customers’ businesses are subject to extensive health and safety regulations that impose, and will continue to impose, significant costs and liabilities, and future regulation could increase those costs and liabilities or effectively prohibit production or use of beryllium-containing products.

 

Our customers and we are subject to laws regulating worker exposure to beryllium. Standards for exposure to beryllium are under review by OSHA and by other governmental and private standard-setting organizations. One result of these reviews will likely be more stringent worker safety standards. Some organizations, such as the California Occupational Health and Safety Administration and the American Conference of Governmental Industrial Hygienists, have adopted standards that are more stringent than the current standards of OSHA. The development, proposal or adoption of more stringent standards may affect buying decisions by the users of beryllium-containing products. If the standards are made more stringent and/or our customers or other downstream users decide to reduce their use of beryllium-containing products, our results of operations, liquidity and financial condition could be materially adversely affected. The impact of this potential adverse effect would depend on the nature and extent of the changes to the standards, the cost and ability to meet the new standards, the extent of any reduction in customer use and other factors. The magnitude of this potential adverse effect cannot be estimated.

 

Our bertrandite ore mining and manufacturing operations are subject to extensive environmental regulations that impose, and will continue to impose, significant costs and liabilities on us, and future regulation could increase these costs and liabilities or prevent production of beryllium-containing products.

 

We are subject to a variety of governmental regulations relating to the environment, including those relating to our handling of hazardous materials and air and wastewater emissions. Some environmental laws impose substantial penalties for noncompliance. Others, such as the federal Comprehensive Environmental Response, Compensation, and Liability Act, impose strict, retroactive and joint and several liability upon entities responsible for releases of hazardous substances. Bertrandite ore mining is also subject to extensive governmental regulation on matters such as permitting and licensing requirements, plant and wildlife protection, reclamation and restoration of mining properties, the discharge of materials into the environment and the effects that mining has on groundwater quality and availability. If we fail to comply with present and future environmental laws and regulations, we could be subject to liabilities or our operations could be interrupted. In addition, future environmental laws and regulations could restrict our ability to expand our facilities or extract our bertrandite ore deposits. These environmental laws and regulations could also require us to acquire costly equipment or to incur other significant expenses in connection with our business, which would increase our costs of production.

 

The availability of competitive substitute materials for beryllium-containing products may reduce our customers’ demand for these products and reduce our sales.

 

In certain product applications, we compete with manufacturers of non-beryllium-containing products, including organic composites, metal alloys or composites, titanium and aluminum. Our customers may choose to use substitutes for beryllium-containing products in their products for a variety of reasons, including, among other things, the lower costs of those substitutes, the health and safety concerns relating to these products and the risk of litigation relating to beryllium-containing products. If our customers use substitutes for beryllium-

containing products in their products, the demand for our beryllium-containing products may decrease, which could reduce our sales.

 

The markets for our beryllium-containing and non-beryllium-containing products are experiencing rapid changes in technology.

 

We operate in markets characterized by rapidly changing technology and evolving customer specifications and industry standards. New products may quickly render an existing product obsolete and unmarketable. For example, at one time we produced beryllium-copper alloys that were used in the production of some golf club heads, but these beryllium-copper alloy club heads are no longer produced by any of our customers. Our growth and future results of operations depend in part upon our ability to enhance existing products and introduce newly developed products on a timely basis that conform to prevailing and evolving industry standards, meet or exceed technological advances in the marketplace, meet changing customer specifications, achieve market acceptance and respond to our competitors’ products.

 

The process of developing new products can be technologically challenging and requires the accurate anticipation of technological and market trends. We may not be able to introduce new products successfully or do so on a timely basis. If we fail to develop new products that are appealing to our customers or fail to develop products on time and within budgeted amounts, we may be unable to recover our significant research and development costs, which could adversely affect our margins and profitability.

 

We are dependent on the successful scheduled completion of a new primary beryllium facility for our future supply of pure beryllium.

 

We have partnered with the Department of Defense to share in the cost of a new beryllium pebble plant for primary beryllium feedstocks. We may experience government funding delays or cancellations, construction delays and quality and/or production issues in start up of this new facility. Any prolonged delays of pure beryllium production from the new pebble plant could negatively impact the Beryllium and Beryllium Composites segment.

 

We are exposed to lawsuits in the normal course of business, which could harm our business.

 

We are currently involved in certain legal proceedings, including those involving product liability claims, and employee and third-party lawsuits relating to exposure to beryllium as well as claims against us of infringement of intellectual property rights of third parties and other claims arising out of the ordinary conduct of our business. Due to the uncertainties of litigation, we can give no assurance that we will prevail on claims made against us in the lawsuits that we currently face or that additional claims will not be made against us in the future. Certain of these matters involve types of claims, that, if they result in an adverse ruling to us, could give rise to substantial liability which could have a material adverse effect on our business, operating results or financial condition.

 

We are presently uninsured for beryllium-related claims where the claimants’ first exposure to beryllium occurred on or after January 1, 2008, and we have not undertaken to estimate the impact of such claims, which have yet to be asserted. In addition, some jurisdictions preclude insurance coverage for punitive damage awards. Accordingly, our profitability could be adversely affected if any current or future claimants obtain judgments for any uninsured compensatory or punitive damages. Further, an unfavorable outcome or settlement of a pending beryllium case or additional adverse media coverage could encourage the commencement of additional similar litigation.

 

Our beryllium-containing and non-beryllium-containing products are deployed in complex applications and may have errors or defects that we find only after deployment.

 

Our products are highly complex, designed to be deployed in complicated applications and may contain undetected defects, errors or failures. Although our products are generally tested during manufacturing, prior to deployment, they can only be fully tested when deployed in specific applications. For example, we sell beryllium-copper alloy strip products in a coil form to some customers, who then stamp the alloy for its specific purpose. On occasion, it is not until such customer stamps the alloy that a defect in the alloy is detected. In addition, we have experienced, on one occasion, a quality issue during the manufacturing ramp up of a new product. Consequently,

our customers may discover errors after the products have been deployed. The occurrence of any defects, errors, or failures could result in installation delays, product returns, termination of contracts with our customers, diversion of our resources, increased service and warranty costs and other losses to our customers, end users or to us. Any of these occurrences could also result in the loss of or delay in market acceptance of our products and could damage our reputation, which could reduce our sales.

 

Many of our customers are subject to significant fluctuations as a result of the cyclical nature of their industries and their sensitivity to general economic conditions, which could adversely affect their demand for our products and reduce our sales and profitability.

 

A substantial number of our customers are in the telecommunications and computer, data storage, aerospace and defense, automotive electronics, industrial components and appliance industries. Each of these industries is cyclical in nature, influenced by a combination of factors which could have a negative impact on our business, including, among other things, periods of economic growth or recession, strength or weakness of the U.S. dollar, the strength of the consumer electronics, automotive electronics and computer industries and the rate of construction of telecommunications infrastructure equipment and government spending on defense.

 

Also, in times when growth rates in our markets slow down, there may be temporary inventory adjustments by our customers that may negatively affect our business.

 

The current global economic crisis is having a negative impact on our financial performance.

 

The global economic crisis continues to adversely affect the domestic and global economies. Some customers are experiencing difficulty in obtaining adequate financing due to the current disruption in the credit markets, which has impacted our sales. Our exposure to bad debt losses may also increase if customers are unable to pay for products previously ordered. The severe recession has also caused higher unemployment rates globally which could have an adverse affect on demand for consumer electronics, which comprised over 50% of our sales in 2008. Continuation or further deterioration of these financial and macroeconomic conditions may have a significant adverse effect on our sales, profitability and results of operations.

 

We may not be able to complete our acquisition strategy or successfully integrate acquired businesses.

 

We have been active over the last several years in pursuing niche acquisitions for one of our subsidiaries, Williams Advanced Materials Inc. We intend to continue to consider further growth opportunities through the acquisition of assets or companies and routinely review acquisition opportunities. We cannot predict whether we will be successful in pursuing any acquisition opportunities or what the consequences of any acquisition would be. Future acquisitions may involve the expenditure of significant funds and management time. Depending upon the nature, size and timing of future acquisitions, we may be required to raise additional financing, which may not be available to us on acceptable terms. Further, we may not be able to successfully integrate any acquired business with our existing businesses or recognize any expected advantages from any completed acquisition.

 

In addition, there may be liabilities that we fail, or are unable, to discover in the course of performing due diligence investigations on the assets or companies we have already acquired or may acquire in the future. We cannot assure that rights to indemnification by the sellers of these assets or companies to us, even if obtained, will be enforceable, collectible or sufficient in amount, scope or duration to fully offset the possible liabilities associated with the business or property acquired. Any such liabilities, individually or in the aggregate, could have a materially adverse effect on our business, financial condition and results of operations.

 

The terms of our indebtedness may restrict our operations, including our ability to pursue our growth and acquisition strategies.

 

The terms of our credit facilities contain a number of restrictive covenants, including restrictions in our ability to, among other things, borrow and make investments and acquire other businesses. These covenants could adversely affect us by limiting our ability to plan for or react to market conditions or to meet our capital needs, as well as adversely affect our ability to pursue our growth, acquisition strategies and other strategic initiatives.

Our failure to comply with the covenants contained in the terms of our indebtedness could result in an event of default which could materially and adversely affect our operating results and our financial condition.

 

The terms of our credit facilities require us to comply with various covenants, including financial covenants. If the current global economic crisis is prolonged, it could have a material adverse impact on our earnings and cash flow which could adversely affect our ability to comply with our financial covenants and could limit our borrowing capacity. Our ability to comply with these covenants depends, in part, on factors over which we may have no control. A breach of any of these covenants could result in an event of default under one or more of the agreements governing our indebtedness which, if not cured or waived, could give the holders of the defaulted indebtedness the right to terminate commitments to lend and cause all amounts outstanding with respect to the indebtedness to be due and payable immediately. Acceleration of any of our indebtedness could result in cross defaults under our other debt instruments. Our assets and cash flow may be insufficient to fully repay borrowings under all of our outstanding debt instruments if some or all of these instruments are accelerated upon an event of default, in which case we may be required to seek legal protection from our creditors.

 

We conduct our sales and distribution operations on a worldwide basis and are subject to the risks associated with doing business outside the United States.

 

We sell to customers outside of the United States from our United States and international operations. We have been and are continuing to expand our geographic reach in Europe and Asia. Shipments to customers outside of the United States accounted for approximately 35% of our sales in 2008, 43% in 2007, and 35% in 2006. We anticipate that international shipments will account for a significant portion of our sales for the foreseeable future. Revenue from non-United States operations (principally Europe and Asia) amounted to approximately 24% of our sales in 2008, 25% in 2007, and 23% in 2006. There are a number of risks associated with international business activities, including:

 

 

Additionally, foreign and international regulations have also impacted our sales, margins and profitability in the past. See also “— Health issues, litigation and government regulation relating to machining and manufacturing of beryllium-containing products could significantly reduce demand for our products, limit our ability to operate and adversely affect our profitability”, found on page 6 of this Form 10-K and “— Our bertrandite ore mining and beryllium-related manufacturing operations and some of our customers’ businesses are subject to extensive health and safety regulations that impose, and will continue to impose, significant costs and liabilities, and future regulation could increase those costs and liabilities or effectively prohibit production or use of beryllium-containing products”, found on page 7 on this Form 10-K. Further, any of these risks could continue in the future.

 

A major portion of our bank debt consists of variable-rate obligations, which subjects us to interest rate fluctuations.

 

Our credit facilities are secured by substantially all of our assets (other than non-mining real property and certain other assets). Our working capital line-of-credit includes variable-rate obligations, which expose us to interest rate risks. If interest rates increase, our debt service obligations on our variable-rate indebtedness would increase even if the amount borrowed remained the same, resulting in a decrease in our net income. We have developed a hedging program to manage the risks associated with interest rate fluctuations, but our program may not effectively eliminate all of the financial exposure associated with interest rate fluctuations. Additional information regarding our market risks is contained in Part II, Item 7A of this Form 10-K.

The availability and prices of some raw materials we use in our manufacturing operations fluctuate, and increases in raw material costs can increase our operating costs.

 

We manufacture engineered materials using various precious and non-precious metals, including gold, silver, palladium, platinum, ruthenium, copper and nickel. The availability of and prices for these raw materials are subject to volatility and are influenced by worldwide economic conditions, speculative action, world supply and demand balances, inventory levels, availability of substitute metals, the U.S. dollar exchange rate, production costs of United States and foreign competitors, anticipated or perceived shortages and other factors. Decreased availability and fluctuating prices of precious and non-precious metals that we use in our manufacturing can increase our operating costs. For example, prices for copper have been very volatile in recent months due to global demand and market conditions. Further, we maintain some precious metals on a consigned inventory basis. The owners of the precious metals charge a fee that fluctuates based on the market price of those metals and other factors. A significant increase in the market price of precious metals or the consignment fee could increase our financing costs, which could increase our operating costs. We use ruthenium for the manufacture of perpendicular magnetic recording technology products for the data storage market. Ruthenium is not widely used or traded on a public market and therefore there is no established market for hedging price exposure. Although our selling price is generally based on our cost to purchase ruthenium, the inventory carrying value may be exposed to market fluctuations. For example, we experienced a 66% drop in the price of ruthenium during the fourth quarter 2008.

 

Because we experience seasonal fluctuations in our sales, our quarterly results will fluctuate, and our annual performance will be affected by the fluctuations.

 

Because many of our European and automotive electronics customers slow or cease operations during the summer months, we sometimes experience weaker demand in the quarters ending in September compared to the quarters ending in March, June and December. We expect this seasonal pattern to continue, which causes our quarterly results to fluctuate. If our revenue during any quarter were to fall below the expectations of investors or securities analysts, our share price could decline, perhaps significantly. Unfavorable economic conditions, lower than normal levels of demand and other occurrences in any of the other quarters could also harm our results of operations.

 

Natural disasters, equipment failures, work stoppages, bankruptcies and other unexpected events may lead our customers to curtail production or shut down their operations.

 

Our customers’ manufacturing operations are subject to conditions beyond their control, including raw material shortages, natural disasters, interruptions in electrical power or other energy services, equipment failures, bankruptcies, work stoppages due to strikes or lockouts, including those affecting the automotive industry, one of our major markets, and other unexpected events. For example, in 2005, Delphi Corporation, a customer of three of our business units and the largest United States supplier of automotive parts, filed for bankruptcy protection. To date, Delphi has not emerged from bankruptcy reorganization. Any of those events could also affect other suppliers to our customers. In either case, those events could cause our customers to curtail production or to shut down a portion or all of their operations, which could reduce their demand for our products and reduce our sales.

 

Unexpected events and natural disasters at our mine could increase the cost of operating our business.

 

A portion of our production costs at our mine are fixed regardless of current operating levels. Our operating levels are subject to conditions beyond our control that may increase the cost of mining for varying lengths of time.

 

These conditions include, among other things, fire, natural disasters, pit wall failures and ore processing changes. Our mining operations also involve the handling and production of potentially explosive materials. It is possible that an explosion could result in death and injuries to employees and others and material property damage to third parties and us. Any explosion could expose us to adverse publicity or liability for damages and materially adversely affect our operations. Any of these events could increase our cost of operations.

Equipment failures and other unexpected events at our facilities may lead to manufacturing curtailments or shutdowns.

 

The manufacturing processes that take place in our mining operation, as well as in our manufacturing facilities, depend on critical pieces of equipment. This equipment may, on occasion, be out of service because of unanticipated failure, and some equipment is not readily available or replaceable. In addition to equipment failures, our facilities are also subject to the risk of loss due to unanticipated events such as fires, explosions or other disasters. Material plant shutdowns or reductions in operations could harm our ability to fulfill our customers’ demands, which could harm our sales and cause our customers to find other suppliers. Further, remediation of any interruption in production capability may require us to make large capital expenditures, which may have a negative effect on our profitability and cash flows. Our business interruption insurance may not cover all of the lost revenues associated with interruptions in our manufacturing capabilities.

 

Many of our manufacturing facilities are dependent on single source energy suppliers, and interruption in energy services may cause manufacturing curtailments or shutdowns.

 

Many of our manufacturing facilities depend on one source for electric power and for natural gas. For example, Utah Power is the sole supplier of electric power to the processing facility for our mining operations in Utah. A significant interruption in service from our energy suppliers due to equipment failures, terrorism or any other cause may result in substantial losses that are not fully covered by our business interruption insurance. Any substantial unmitigated interruption of our operations due to these conditions could harm our ability to meet our customers’ demands and reduce our sales.

 

If the price of electrical power, fuel or other energy sources increases, our operating expenses could increase significantly.

 

We have numerous milling and manufacturing facilities and a mining operation, which depend on electrical power, fuel or other energy sources. See “Item 2. — Properties,” found on page 16 of this Form 10-K. Our operating expenses are sensitive to changes in electricity prices and fuel prices, including natural gas prices. Prices for electricity and natural gas have continued to increase and can fluctuate widely with availability and demand levels from other users. During periods of peak usage, supplies of energy may be curtailed, and we may not be able to purchase energy at historical market rates. While we have some long-term contracts with energy suppliers, we are exposed to fluctuations in energy costs that can affect our production costs. Although we enter into forward-fixed price supply contracts for natural gas and electricity for use in our operations, those contracts are of limited duration and do not cover all of our fuel or electricity needs. Price increases in fuel and electricity costs will continue to increase our cost of operations.

 

We have a limited number of manufacturing facilities, and damage to those facilities could interrupt our operations, increase our costs of doing business and impair our ability to deliver our products on a timely basis.

 

Some of our facilities are interdependent. For instance, our manufacturing facility, in Elmore, Ohio relies on our mining operation for its supply of beryllium hydroxide used in production of most of its beryllium-containing materials. Additionally, our Reading, Pennsylvania, Fremont, California and Tucson, Arizona manufacturing facilities are dependent on materials produced by our Elmore, Ohio manufacturing facility and our Wheatfield, New York manufacturing facility is dependent on our Buffalo, New York manufacturing facility. See “Item 2 — Properties”, found on page 16 of this Form 10-K. The destruction or closure of any of our manufacturing facilities or our mine for a significant period of time as a result of fire, explosion, act of war or terrorism or other natural disaster or unexpected event may interrupt our manufacturing capabilities, increase our capital expenditures and our costs of doing business and impair our ability to deliver our products on a timely basis. In such an event, we may need to resort to an alternative source of manufacturing or to delay production, which could increase our costs of doing business. Our property damage and business interruption insurance may not cover all of our potential losses and may not continue to be available to us on acceptable terms, if at all.

Our lengthy and variable sales and development cycle makes it difficult for us to predict if and when a new product will be sold to customers.

 

Our sales and development cycle, which is the period from the generation of a sales lead or new product idea through the development of the product and the recording of sales, may typically take up to two or three years, making it very difficult to forecast sales and results of operations. Our inability to accurately predict the timing and magnitude of sales of our products, especially newly introduced products, could affect our ability to meet our customers’ product delivery requirements or cause our results of operations to suffer if we incur expenses in a particular period that do not translate into sales during that period, or at all. In addition, these failures would make it difficult to plan future capital expenditure needs and could cause us to fail to meet our cash flow requirements.

 

Future terrorist attacks and other acts of violence or war may directly harm our operations.

 

Future terrorist attacks or other acts of violence or war may directly impact our physical facilities. For example, our Elmore, Ohio facility is located near and derives power from a nuclear power plant, which could be a target for a terrorist attack. In addition, future terrorist attacks, related armed conflicts or prolonged or increased tensions in the Middle East or other regions of the world could cause consumer confidence and spending to decrease, decreasing demand for consumer goods that contain our products. Further, when the United States armed forces are involved in active hostilities or large-scale deployments, defense spending tends to focus more on meeting the physical needs of the troops, and planned expenditures on weapons and other systems incorporating our products may be reduced or deferred. Any of these occurrences could also increase volatility in the United States and worldwide financial markets, which could negatively impact our sales.

 

We may be unable to access the financial markets on favorable terms.

 

The inability to raise capital on favorable terms, particularly during times of uncertainty in the financial markets, could impact our ability to sustain and grow our business and would increase our capital costs. In particular, the substantial volatility in world capital markets due to the global economic crisis has had a significant negative impact on the domestic and global financial markets.

 

We rely on access to financial markets as a significant source of liquidity for capital requirements not satisfied by cash on hand or operating cash flow. Our access to the financial markets could be adversely impacted by various factors, including:

 

 

All of these factors have adversely impacted our access to the financial markets at various times over the last five years. The recent global economic crisis may make it difficult for us to access the credit market and to obtain financing or refinancing, as the case may be, to the extent necessary, on satisfactory terms or at all.

 

Low investment performance by our domestic pension plan assets may require us to increase our pension liability and expense, which may require us to fund a portion of our pension obligations and divert funds from other potential uses.

 

We provide defined benefit pension plans to eligible employees. Our pension expense and our required contributions to our pension plans are directly affected by the value of plan assets, the projected rate of return on plan assets, the actual rate of return on plan assets and the actuarial assumptions we use to measure our defined benefit pension plan obligations, including the rate at which future obligations are discounted to a present value, or

the discount rate. As of December 31, 2008, for pension accounting purposes, we assumed an 8.25% rate of return on pension assets.

 

Lower investment performance of our pension plan assets resulting from a decline in the stock market could significantly increase the deficit position of our plans. Should the pension asset return fall below our expectations, it is likely that future pension expenses would increase. The actual return on our plan assets for the twelve months ending December 31, 2008 was a loss of 24%.

 

We establish the discount rate used to determine the present value of the projected and accumulated benefit obligation at the end of each year based upon the available market rates for high quality, fixed income investments. An increase in the discount rate would reduce the future pension expense and, conversely, a lower discount rate would raise the future pension expense.

 

Based on current guidelines, assumptions and estimates, including stock market prices and interest rates, we anticipate that we will be required to make a cash contribution of approximately $18.3 million to our pension plan in 2009. If our current assumptions and estimates are not correct, a contribution in years beyond 2009 may be greater than the projected 2009 contribution required.

 

We cannot predict whether changing market or economic conditions, regulatory changes or other factors will further increase our pension expenses or funding obligations, diverting funds we would otherwise apply to other uses.

 

Our expenditures for post-retirement health benefits could be materially higher than we have predicted if our underlying assumptions prove to be incorrect.

 

We also provide post-retirement health benefits to eligible employees. Our retiree health expense is directly affected by the assumptions we use to measure our retiree health plan obligations, including the assumed rate at which health care costs will increase and the discount rate used to calculate future obligations. For retiree health accounting purposes, we decreased the assumed rate at which health care costs will increase for the next year to 8% at December 31, 2008 from 9% at December 31, 2007. In addition, we have assumed that this health care cost increase trend rate will decline to 5% by 2012. We have used the same discount rates for our retiree health plans that we use for our pension plan accounting.

 

Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A one percentage point increase in assumed health care cost trend rates would have increased the post-employment benefits included among the liabilities in our balance sheet by $0.8 million at December 31, 2008.

 

We cannot predict whether changing market or economic conditions, regulatory changes or other factors will further increase our retiree health care expenses or obligations, diverting funds we would otherwise apply to other uses.

 

We are subject to fluctuations in currency exchange rates, which may negatively affect our financial performance.

 

A significant portion of our sales is conducted in international markets and priced in currencies other than the U.S. dollar. Revenues from customers outside of the United States (principally Europe and Asia) amounted to 35% of sales in 2008, 43% in 2007 and 35% in 2006. A significant part of these international sales are priced in currencies other than the U.S. dollar. Significant fluctuations in currency values relative to the U.S. dollar may negatively affect our financial performance. In the past, fluctuations in currency exchange rates, particularly for the euro and the yen, have impacted our sales, margins and profitability. The fair value of our net liability relating to outstanding foreign currency contracts was $1.2 million at December 31, 2008, indicating that the average hedge rates were unfavorable compared to the actual year-end market exchange rates. While we may hedge our currency transactions to mitigate the impact of currency price volatility on our earnings, any hedging activities may not be successful.

Our holding company structure causes us to rely on funds from our subsidiaries.

 

We are a holding company and conduct substantially all our operations through our subsidiaries. As a holding company, we are dependent upon dividends or other intercompany transfers of funds from our subsidiaries. The payment of dividends and other payments to us by our subsidiaries may be restricted by, among other things, applicable corporate and other laws and regulations, agreements of the subsidiaries and the terms of our current and future indebtedness.

 

Our financial results are likely to be negatively impacted by an impairment of goodwill pursuant to Statement No. 142 should our shareholder equity exceed our market capitalization for a number of quarters.

 

A goodwill impairment charge may be triggered by a reduction in actual and projected cash flows, which could be negatively impacted by the market price of our common shares. Our goodwill balance at December 31, 2008 was $35.8 million. Any required non-cash impairment charge could significantly reduce this balance and have a material impact on our reported financial position and results of operations.

 

 

None.

 

We operate manufacturing plants, service and other facilities throughout the world. During 2008, we made effective use of our productive capacities at our principal facilities. We believe that the quality and production capacity of our facilities is sufficient to maintain our competitive position for the foreseeable future. Information as of December 31, 2008, with respect to our significant facilities that are owned or leased, and the respective segments in which they are included, is set forth below.

 

 

 

 

In addition to the above, there are 7,500 acres in Juab County, Utah with respective mineral rights from which the beryllium-bearing ore, bertrandite, is mined by the open pit method. A portion of the mineral rights is held under lease. Ore reserve data can be found in Part II, Item 7 of this Form 10-K.

 

Our subsidiaries and our holding company are subject, from time to time, to a variety of civil and administrative proceedings arising out of our normal operations, including, without limitation, product liability claims, health, safety and environmental claims and employment-related actions. Among such proceedings are the cases described below.

 

Beryllium Claims

 

As of December 31, 2008, our subsidiary, Brush Wellman Inc., was a defendant in nine proceedings in various state and federal courts brought by plaintiffs alleging that they have contracted, or have been placed at risk of contracting, chronic beryllium disease or other lung conditions as a result of exposure to beryllium. Plaintiffs in beryllium cases seek recovery under negligence and various other legal theories and seek compensatory and punitive damages, in many cases of an unspecified sum. Spouses of some plaintiffs claim loss of consortium.

 

As of December 31, 2007 there were nine beryllium cases (involving 31 plaintiffs) and as of December 31, 2008, there were nine beryllium cases (involving 36 plaintiffs). During 2008:

 

 

In addition, in one purported class action (involving one named plaintiff), the court granted summary judgment of all defendants and dismissed the complaint, but the plaintiff has filed an appeal. In a second purported class action (involving nine named plaintiffs), the court denied the motion for class certification, but the plaintiffs have filed an appeal.

 

The nine pending beryllium cases as of December 31, 2008 fall into two categories: Seven cases involving third-party individual plaintiffs, with 20 individuals (and four spouses who have filed claims as part of their spouse’s case and two children who have filed claims as part of their parent’s case) and two purported class actions, involving ten named plaintiffs, as discussed more fully below. Claims brought by third-party plaintiffs (typically employees of our customers or contractors) are generally covered by varying levels of insurance.

 

The first purported class action is Manuel Marin, et al. v. Brush Wellman Inc., filed in Superior Court of California, Los Angeles County, case number BC299055, on July 15, 2003. The named plaintiffs are Manuel Marin, Lisa Marin, Garfield Perry and Susan Perry. The defendants are Brush Wellman, Appanaitis Enterprises, Inc., and Doe Defendants 1 through 100. A First Amended Complaint was filed on September 15, 2004, naming five additional plaintiffs. The five additional named plaintiffs are Robert Thomas, Darnell White, Leonard Joffrion, James Jones and John Kesselring. The plaintiffs allege that they have been sensitized to beryllium while employed at the Boeing Company. The plaintiffs’ wives claim loss of consortium. The plaintiffs purport to represent two classes of approximately 250 members each, one consisting of workers who worked at Boeing or its predecessors and are beryllium sensitized and the other consisting of their spouses. They have brought claims for negligence, strict liability — design defect, strict liability — failure to warn, fraudulent concealment, breach of implied warranties, and unfair business practices. The plaintiffs seek injunctive relief, medical monitoring, medical and health care provider reimbursement, attorneys’ fees and costs, revocation of business license, and compensatory and punitive damages. Messrs. Marin, Perry, Thomas, White, Joffrion, Jones and Kesselring represent current and past employees of Boeing in California; and Ms. Marin and Ms. Perry are spouses. Defendant Appanaitis Enterprises, Inc. was dismissed on May 5, 2005. Plaintiffs’ motion for class certification, which the Company opposed, was heard by the court on February 8, 2008, and the motion was denied by the court on May 7, 2008. Plaintiffs filed a notice of appeal on May 20, 2008.

 

The second purported class action is Gary Anthony v. Small Tube Manufacturing Corporation d/b/a Small Tube Products Corporation, Inc., et al., filed in the Court of Common Pleas of Philadelphia County, Pennsylvania, case number 000525, on September 7, 2006. The case was removed to the U.S. District Court for the Eastern District of Pennsylvania, case number 06-CV-4419, on October 4, 2006. The only named plaintiff is Gary Anthony. The defendants are Small Tube Manufacturing Corporation, d/b/a Small Tube Products Corporation, Inc.; Admiral

Metals Inc.; Tube Methods, Inc., and Cabot Corporation. The plaintiff purports to sue on behalf of a class of current and former employees of the U.S. Gauge facility in Sellersville, Pennsylvania who have ever been exposed to beryllium for a period of at least one month while employed at U.S. Gauge. The plaintiff has brought claims for negligence. Plaintiff seeks the establishment of a medical monitoring trust fund, cost of publication of approved guidelines and procedures for medical screening and monitoring of the class, attorneys’ fees and expenses. Defendant Tube Methods, Inc. filed a third-party complaint against Brush Wellman Inc. in that action on November 15, 2006. Tube Methods alleges that Brush supplied beryllium-containing products to U.S. Gauge, and that Tube Methods worked on those products, but that Brush is liable to Tube Methods for indemnification and contribution. Brush moved to dismiss the Tube Methods complaint on December 22, 2006. On January 12, 2007, Tube Methods filed an amended third-party complaint, which Brush moved to dismiss on January 26, 2007; however, the Court denied the motion on September 28, 2007. Brush filed its answer to the amended third-party complaint on October 19, 2007. On November 14, 2007, two of the defendants filed a joint motion for an order permitting discovery to make the threshold determination of whether plaintiff is sensitized to beryllium. On February 29, 2008, Brush filed a motion for summary judgment based on plaintiff’s lack of any substantially increased risk of CBD. Oral argument on this motion took place on June 13, 2008. On September 30, 2008, the court granted the motion for summary judgment in favor of all of the defendants and dismissed plaintiff’s class action complaint. On October 29, 2008, plaintiff filed a notice of appeal.

 

Subsequent Events

 

From January 1, 2009 to February 20, 2009, in one case (involving five plaintiffs), there was a stipulation of voluntary dismissal of one plaintiff. In one case (involving six plaintiffs), the court granted the plaintiffs’ motion to add two additional plaintiffs. In one case (involving eight plaintiffs), in which the trial court had granted summary judgment on all claims, the Court of Appeals affirmed the trial court’s judgment on January 13, 2009; the plaintiffs sought a rehearing by the Court of Appeals, which was denied by the Court on February 10, 2009.

 

Other Claims

 

One of our subsidiaries, Williams Advanced Materials Inc. (WAM), is a party to patent litigation in the U.S. involving Target Technology Company, LLC of Irvine, California (Target). The litigation involves patents directed to technology used in the production of DVD-9s, which are high storage capacity DVDs, and other optical recording media. The patents at issue primarily concern certain silver alloys used to make the semi-reflective layer in DVD-9s, a thin metal film that is applied to a DVD-9 through a process known as sputtering. The raw material used in the sputtering process is called a target. Target alleges that WAM manufactures and sells infringing sputtering targets to DVD manufacturers.

 

In the first action, filed in April 2003 by WAM against Target in the U.S. District Court, Western District of New York (case no. 03-CV-0276A (SR)) (the NY Action), WAM has asked the Court for a judgment declaring certain Target patents invalid and/or unenforceable and awarding WAM damages. Target counterclaimed alleging infringement of those patents and seeking a judgment for infringement, an injunction against further infringement and damages for past infringement. Following certain proceedings in which WAM was denied an injunction to prevent Target from suing and threatening to sue WAM’s customers, Target filed an amended counterclaim and a third-party complaint naming certain of WAM’s customers and other entities as parties to the case and adding related other patents to the NY Action. The action temporarily was stayed pending resolution of the ownership issue in the CA Action (defined below), as discussed more fully below.

 

Target in September 2004 filed in the U.S. District Court, Central District of California (case no. SAC04-1083 DOC (MLGx)) a separate action for infringement of one of the same patents named in the NY Action (the CA Action), naming as defendants WAM and certain of WAM’s customers who purchase certain WAM sputtering targets. Target sought a judgment that the patent is valid and infringed by the defendants, a permanent injunction, a judgment on ownership of certain Target patents, damages adequate to compensate Target for the infringement, treble damages and attorneys’ fees and costs. In April 2007, Sony DADC U.S., Inc. among other Sony companies (Sony) had intervened in the CA Action claiming ownership of that patent and others of the patents that Target is seeking to enforce in the NY Action. Sony’s claim was based on its prior employment of the patentee and Target’s founder, Han H. Nee (Nee), and had included a demand for damages against both Target and Nee. WAM on behalf

of itself and its customers has a paid-up license from Sony under any rights that Sony has in those patents. Although trial of the CA Action had been scheduled for March 2009, in December 2008, a confidential settlement agreement was reached between Target and Sony, as well as a partial settlement agreement between Target and WAM releasing WAM and its customers from infringement of the one named patent. As a result, the issues not subject to any settlement were (1) a remaining count in which the Target parties had requested a judgment declaring that Target is the owner of certain of the Target patents and (2) WAM’s request for sanctions against Target.

 

Subsequent Events

 

Pursuant to various stipulations filed by the parties in the CA Action, the Court on January 6, 2009 ordered a dismissal with prejudice of all of the respective intervention claims and counterclaims between the Target parties and the Sony companies, dismissal with prejudice of all claims by Target against WAM and its defendant customers, and dismissal without prejudice of the counterclaims by WAM and its defendant customers, the exception being the remaining declaratory judgment count on patent ownership. Also following motions filed by the parties, the Court in the CA Action on January 26, 2009 ordered that the case and remaining issues be transferred to the Court in the NY Action. As a result, the stay in the NY Action has been lifted, and the parties have resumed pre-trial proceedings with a trial currently expected to be held in 2010.

 

 

No matters were submitted to a vote of security holders during the fiscal fourth quarter of 2008.

 

Item 5.  MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

Market Information and Dividends

 

(a) The Company’s common shares are listed on the New York Stock Exchange under the symbol “BW”. As of February 13, 2009 there were approximately 1,440 shareholders of record. The table below is a summary of the range of market prices with respect to common shares, during each quarter of fiscal years 2008 and 2007. We did not pay any dividends in 2008 or 2007. We have no current intention to declare dividends on our common shares in the near term. Our current policy is to retain all funds and earnings for the use in the operation and expansion of our business.

 

 

On August 1, 2008, we announced that our Board of Directors had approved a share repurchase program authorizing the purchase of up to one million (1,000,000) of our common shares. The share repurchases may be made from time to time through brokers on the New York Stock Exchange. The repurchase program may be suspended or discontinued at any time.

 

During the three months ended December 31, 2008, we repurchased 223,114 shares under this program at an average price of $13.03. On December 31, 2008, we also reacquired common shares in connection with employee compensation plans, which were not part of the share repurchase program. Additional information about these transactions is presented in the table below.

 

 

 

Performance Graph

 

The following graph sets forth the cumulative shareholder return on our common shares as compared to the cumulative total return of the S&P SmallCap 600 Index and the Russell 2000 Index as Brush Engineered Materials Inc. is a component company of these indices.

 

 

 

The above graph assumes that the value of our common shares and each index was $100 on December 31, 2003 and that all dividends, if paid, were reinvested.

 

Brush Engineered Materials Inc. and Subsidiaries

 

Subsequent to the earnings release of the Company’s unaudited Consolidated Statements of Income for the Years Ended December 31, 2008, 2007 and 2006 on February 5, 2009, adjustments were recorded to accounts payable and other balance sheet accounts that resulted in an $0.8 million increase in cost of sales for 2008. Gross margin and operating profit were reduced by this same amount from what was previously released. Net income for 2008 was reduced from $18.9 million to $18.4 million and diluted earnings per share from $0.92 to $0.89. The data presented in the following chart, as well as the data presented in Management’s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 and the Financial Statements and Supplementary Data in Item 8 of this Annual Report on Form 10-K include the impact of these adjustments.

 

 

Capital expenditures shown above include amounts spent under government contracts for which reimbursements were received from the government in the amounts of $8.0 million and $3.5 million in 2008 and 2007, respectively.

 

Changes in deferred tax valuation allowances decreased income tax expense by $21.8 million, $8.1 million and $9.3 million in 2006, 2005 and 2004, respectively.

 

See Notes to Consolidated Financial Statements.

 

OVERVIEW

 

We are an integrated producer of high performance specialty engineered materials used in a variety of electrical, electronic, thermal and structural applications. Our products are sold into numerous markets, including telecommunications and computer, data storage, aerospace and defense, automotive electronics, industrial components, appliance and medical.

 

After five straight years of growth, sales declined $46.0 million from $955.7 million in 2007 to $909.7 million in 2008. Sales from the majority of our businesses were strong for the first three quarters of the year; demand from many of our key markets, including portions of the telecommunications and computer, industrial components, medical and defense markets, was solid. Media sales into the data storage market, however, declined significantly in 2008 due to a combination of factors. This fall-off, coupled with a slowdown across several of our large markets in the fourth quarter, largely due to the global economic crisis and its impact on consumer spending, resulted in sales being 5% lower in 2008 than in 2007.

 

We acquired the operating assets of Techni-Met, Inc. in the first quarter 2008. Techni-Met’s complementary technology expanded our presence in the medical market and provides opportunities for growth in other markets. Techni-Met provided an immediate benefit to margins and profits in 2008.

 

The gross margin rate was 17% of sales in 2008, down from 21% in 2007. A large portion of this difference was due to a $15.2 million inventory write-down as a result of the significant decline in ruthenium market prices in 2008. Increases in manufacturing overhead costs, the impact of metal prices and other factors combined to more than offset the margin benefits from improved pricing in portions of our businesses.

 

Operating profit was $28.1 million in 2008, a decline of $56.4 million from 2007. Profit in 2007 included several unusual items, including a net $12.7 million benefit from ruthenium price and quality issues and an $8.7 million litigation settlement gain. In addition to these items, profit declined in 2008 relative to 2007 due to the lower sales volumes, the inventory write-down and other factors.

 

Cash flow from operations was a solid $76.8 million in 2008, an improvement of $25.9 million over 2007. The strong cash flow allowed us to acquire Techni-Met and fund capital expenditures and stock repurchases while only increasing debt $6.3 million.

 

RESULTS OF OPERATIONS

 

 

Sales of $909.7 million in 2008 were $46.0 million, or 5%, lower than sales of $955.7 million in 2007 while sales in 2007 were 25% higher than sales of $763.1 million in 2006. International sales declined 23% in 2008 from 2007 after growing 57% in 2007 over 2006. Domestic sales improved 9% in 2008 and 2007 over the respective prior years.

 

Sales of targets manufactured from ruthenium and other materials for media applications in the data storage market declined $141.9 million, or 93%, in 2008 from the high levels seen in 2007. This decline was due to quality issues, a material specification change, lower metal prices and softer market conditions, particularly late in the year. In addition, the sales value was reduced in 2008 as a result of a growing trend away from manufacturing targets with Company-supplied material to manufacturing targets with customer-supplied material on a toll basis. Media sales in 2007 were more than double the sales in 2006 and accounted for the majority of the growth in our total sales in that

year. This growth was fueled largely by our customers’ conversion to the perpendicular magnetic recording technology used in the manufacture of hard disk drives.

 

Growth in other portions of our business, the acquisition of Techni-Met and higher metal prices offset a portion of the decline in media sales in 2008.

 

Sales to the telecommunications and computer market grew 19% in both 2008 and 2007 over the respective prior years. However, sales into this market slowed down in the fourth quarter 2008 as the global economic crisis reduced consumer spending levels. Sales for defense applications, which were solid throughout 2007, strengthened again in 2008. Sales into the medical market grew in 2008, in part due to the acquisition of Techni-Met. Demand from the oil and gas market improved during 2007 and for the first three quarters of 2008. During the fourth quarter 2008, demand softened due to a combination of the decline in oil prices and Hurricane Ike, which temporarily disrupted oil and gas operations in the southern U.S. Sales into the appliance market grew in each of the last two years. Automotive electronics sales declined for the second year in a row, although improved sales into the European automotive market in the first half of 2008 helped to offset a portion of the weakness in the domestic market.

 

The development of new products and applications into existing and/or emerging markets has provided a benefit to sales across each of our four reportable segments in the last two years. One of these emerging markets is solar energy. While our sales to this market were relatively small in 2008, solar energy applications offer numerous growth opportunities for our materials and technologies from each of our main businesses.

 

Sales are affected by metal prices as changes in precious metal and a portion of the changes in base metal prices, primarily copper, are passed on to our customers. Copper prices declined significantly in the fourth quarter 2008 but on average for the year were higher than in 2007. Prices for gold and the other precious metals we use were volatile in 2008 and on average were higher in 2008 than 2007. Ruthenium prices fell significantly during 2008 and on average were well below 2007. In aggregate, the average metal prices in 2007 were higher than they were in 2006. We estimate that the net metal price impact increased sales $50.7 million in 2008 and $36.8 million in 2007 relative to the respective prior year.

 

In the first quarter 2008, we reduced sales and accounts receivable by $2.6 million in order to correct an error from 2007. The error was discovered late in the first quarter 2008 and resulted from inaccurate billings to one customer during the second half of 2007. We determined that the error was not material in accordance with SAB 99 and APB No. 28 and therefore the 2007 financial statements were not adjusted. Correction of the error also reduced the gross margin by $2.6 million in the first quarter 2008.

 

Gross margin was $152.1 million, or 17% of sales, in 2008, $196.7 million, or 21% of sales, in 2007 and $162.2 million, or 21% of sales, in 2006. Margins in 2008 and 2007 were affected by the following issues associated with the production and sale of ruthenium and related products:

 

 

Margins, therefore, declined by a net $27.9 million from 2007 to 2008 as a result of the above factors.

 

The lower sales volume in 2008 reduced margins by an estimated $21.0 million as compared to 2007. Manufacturing overhead costs were higher in 2008 than in 2007 due to increases in utilities, freight and other items.

The margin generated by Techni-Met, improved pricing in portions of the business and a favorable foreign currency translation effect offset a portion of the impact of the decline in volume, changes in product mix and higher overhead costs.

 

Gross margin improved $34.5 million in 2007 over 2006. The increased sales volume in 2007 generated an estimated $23.7 million of additional margin; the incremental margin earned on the sales growth was less than the prior-year margin rate as the majority of the sales increase was in ruthenium products that had a very high metal content and cost. We made improvements to the pricing for our copper-based alloy products in the fourth quarter of 2006 that allowed for an increase in the percentage of copper-based sales subject to the copper cost pass-through. The full year benefit of that improved pricing in 2007, however, was more than offset by an unfavorable change in product mix, manufacturing inefficiencies and other factors. Gross margin in 2007 also benefited from the items associated with the production and sale of ruthenium products described above.

 

Selling, general and administrative expenses (SG&A) were $104.8 million in 2008 (12% of sales), $110.1 million in 2007 (12% of sales) and $111.0 million in 2006 (15% of sales). Expenses declined 5% in 2008 from 2007 after declining 1% in 2007 from 2006.

 

The decreased expenses in 2008 as compared to 2007 resulted from lower incentive compensation expense offset in part by the addition of Techni-Met, higher retirement costs and other factors. The slight decline in expenses in 2007 resulted primarily from lower incentive compensation expense, retirement plan costs and corporate administrative expenses offset in part by higher selling and marketing costs, primarily overseas.

 

The incentive compensation expense on plans designed to pay in cash declined $8.2 million in 2008 from 2007 and $3.3 million in 2007 from the 2006 level. The changes in the annual expense were caused by the performance of the individual businesses relative to their plans’ objectives. Stock-based compensation expense, including the expense for performance shares, stock options, stock appreciation rights and restricted stock, was $2.6 million in 2008, $3.9 million in 2007 and $1.7 million in 2006. The decline in 2008 from 2007 was due to a lower expense for the performance shares as a result of our actual and projected performance.

 

Expenses for the U.S. defined benefit pension plan and certain other domestic retirement plans were $0.4 million higher in 2008 than in 2007 and $1.3 million lower in 2007 than in 2006. The major causes for the difference in expense between years included the plan valuation assumptions for each year, the actual performance of the plans and other factors. The majority of these retirement costs were charged to SG&A expense, although a portion of the cost was included in cost of sales and a much smaller portion in research and development expenses.

 

International SG&A expenses, excluding incentive compensation, increased $0.6 million in 2008 over 2007, largely due to the translation effect of the weaker dollar, and grew $2.9 million in 2007 over 2006 due to the expansion of our overseas operations and increased sales and marketing support efforts.

 

Domestic selling, marketing and distribution costs in 2008 were flat with 2007. These expenses increased in 2007 and 2006 in order to support the sales growth in those years. The increase in 2007 was offset in part by savings from the closure of the New Jersey service center late in 2006. One-time closure costs totaled $1.1 million in 2006.

 

Corporate administrative expenses were up $3.0 million in 2008 compared to 2007. The increase was largely due to higher legal, compliance and information technology costs. Total administrative expenses also increased in 2008 due to the acquisition of Techni-Met. Corporate administrative expenses declined $0.7 million in 2007 from 2006.

 

The litigation settlement gain of $1.1 million in 2008 represents the favorable settlement of a lawsuit, net of legal fees, in which we sought recovery of our rights under a previously signed indemnity agreement.

 

The litigation gain of $8.7 million in 2007 resulted from the settlement of a lawsuit against our former insurers in the fourth quarter of that year. We originally filed the lawsuit in order to resolve a dispute over how insurance coverage should be applied to incurred indemnity losses and defense costs. The court previously had issued a summary judgment in our favor in the third quarter 2006 and awarded us damages of $7.8 million. The defendants did not pay the award at that time and, due to the uncertainty of the appeal process, we did not record the benefits of that award in our Consolidated Financial Statements. Under the terms of the settlement, the insurers agreed to pay us

$17.5 million and to provide enhanced insurance coverage. This enhanced insurance includes occurrence-based coverage for years up to the date of the settlement, including years when we did not have any beryllium-related product liability insurance. We agreed to dismiss our bad faith claim against the insurers, which was scheduled to go to trial in the first quarter 2008, as well as the prior damage award of $7.8 million.

 

We applied $1.1 million of the settlement against amounts recorded on our Consolidated Balance Sheet as recoverable amounts for previously incurred indemnity and defense costs. The remaining $16.4 million was credited to income on the Consolidated Statement of Income. We incurred $7.7 million of legal fees pursuing the lawsuit and negotiating the settlement agreement in 2007, yielding a net pre-tax benefit to income of $8.7 million.

 

One of the insurers paid $6.2 million, which represented their share of the settlement, directly to our attorneys prior to December 31, 2007 in partial settlement of our fees, reducing our receivable from the insurers and the payable to our attorneys by the same amount. The remaining $11.3 million due to us was recorded in other receivables on the Consolidated Balance Sheet as of December 31, 2007 and was subsequently paid in full in the first quarter 2008.

 

Research and development expenses (R&D) were $6.5 million in 2008, $5.0 million in 2007 and $4.2 million in 2006. R&D expenses were below 1% of sales in each of the last three years, although we did increase our R&D spending and activity levels in each of the last two years. In the fourth quarter 2006, we consolidated an R&D laboratory that was in the Cleveland, Ohio facility into the existing laboratory in Elmore, Ohio in order to improve efficiencies, response times and provide additional support to manufacturing operations. R&D efforts are focused on developing new products and applications as well as continuing improvements in our existing products.

 

Other-net expense for each of the last three years is summarized in the following table:

 

 

Foreign currency exchange gains and losses result from movements in value of the U.S. dollar against the euro, yen and sterling and the maturity of hedge contracts. The amortization of intangible assets increased in 2008 over 2007 due to the intangible assets purchased as part of the Techni-Met acquisition in the first quarter 2008. See Note E to the Consolidated Financial Statements. Metal financing fees are a function of the quantity and market price of precious metals held on consignment and the consignment fee rate.

 

The income or expense on the directors’ deferred compensation plan is a function of the outstanding shares in the plan and movements in the market price of our stock. In 2008, the share price decreased, which reduced our liability and created income. In 2007 and 2006, the share price increased, which increased our liability to the plan and resulted in a higher expense. Derivative ineffectiveness represents changes in the fair value of a derivative financial instrument that does not qualify for the favorable hedge accounting treatment. This derivative instrument matured in the fourth quarter 2008.

 

In the first quarter of 2007, we sold substantially all of the operating assets and liabilities of Circuits Processing Technology, Inc. (CPT), a wholly owned subsidiary that manufactures thick film circuits, for $2.2 million. CPT, which was acquired in 1996, was a small operation with limited growth opportunities. The loss on the sale was approximately $0.3 million.

 

Other-net expense also includes bad debt expense, cash discounts, gains and losses on the sale of fixed assets and other non-operating items.

Operating profit of $28.1 million was $56.4 million less than the record-high operating profit of $84.5 million generated in 2007. The lower of cost or market charge in 2008 compared to the ruthenium pricing benefit net of the lower of cost or market charge in 2007 and the differences in litigation settlement gain between years accounted for $35.5 million of the decline in profit. The remaining $20.9 million decline in profit was due to the margin impact from the lower sales volumes in 2008, increased manufacturing overhead costs, higher amortization expense, foreign currency exchange losses and other factors.

 

The operating profit in 2007 was $40.7 million higher than the operating profit of $43.8 million in 2006. The aforementioned 2007 net ruthenium benefit and the litigation settlement gain accounted for $21.4 million of the profit improvement in 2007 over 2006, while all other factors improved operating profit a combined $19.3 million, or 47%, over 2006.

 

Operating profit was 3% of sales in 2008, 9% of sales in 2007 and 6% of sales in 2006.

 

Interest expense was $2.0 million in 2008, $1.8 million in 2007 and $4.1 million in 2006. The average debt level was higher throughout 2008 than in 2007, primarily due to the Techni-Met acquisition, but the average borrowing rate was lower. The reduced expense in 2007 as compared to 2006 resulted primarily from lower outstanding debt levels in 2007.

 

Income before income taxes was $26.1 million in 2008 compared to $82.7 million in 2007. Income before income taxes in 2007 was more than twice the income before income taxes of $39.7 million generated in 2006.

 

The income tax expense (benefit) for 2008, 2007 and 2006, including the movement in the deferred tax valuation allowance, is summarized as follows:

 

 

In calculating the tax expense prior to movements in the valuation allowance, the effects of percentage depletion, executive compensation and foreign source income and deductions were major causes of the differences between the effective and statutory rates for all three years. The production deduction was also a major cause for the difference between the effective and statutory rates in 2008 and 2007. In 2008, the effective rate was lowered as a result of a reduction in the tax reserves in accordance with Financial Interpretation No. 48. See Note P to the Consolidated Financial Statements for a reconciliation of the statutory and effective tax rates.

 

In 2006, we reversed $21.8 million to income, which represented substantially all of the domestic and the majority of the foreign deferred tax valuation allowance remaining on the balance sheet that was originally recorded in 2002 in accordance with Statement No. 109, “Accounting for Income Taxes”. The valuation allowance was initially recorded because we determined that the deferred tax assets were impaired due to cumulative operating losses at that time. The valuation allowance was adjusted up and down in subsequent years depending upon utilization of the assets and other factors. In the fourth quarter 2006, as a result of improved actual and projected earnings, we demonstrated that it was more likely than not that we could utilize our deferred tax assets and the valuation allowance was reversed accordingly. An immaterial valuation allowance associated with our subsidiary in the United Kingdom was not reversed and remained on the balance sheet.

 

In 2008 and 2007, we recorded deferred tax assets associated with certain state tax carryforwards as a reduction to the tax expense. However, the benefit in each year was offset by the recording of valuation allowances due to the uncertainty of realizing these assets.

 

The valuation allowance did not affect any tax payments or refunds in the three years presented.

 

Net income was $18.4 million, or $0.89 per share diluted, in 2008, $53.3 million, or $2.59 per share diluted, in 2007 and $49.6 million, or $2.45 per share diluted, in 2006.

 

Net income and earnings per share did not grow proportionately with income before income taxes in 2007 as compared to 2006 due to the favorable reversal of the $21.8 million valuation allowance in 2006.

Segment Disclosures

 

The Company has four reportable segments. Williams Advanced Materials Inc. (WAM) and its subsidiaries are reported as Advanced Material Technologies and Services. Alloy Products, including Brush Resources Inc., is reported as Specialty Engineered Alloys. Beryllium Products is known as Beryllium and Beryllium Composites while Technical Materials, Inc. (TMI) is reported as Engineered Material Systems. Results by segment are shown in Note M to the Consolidated Financial Statements.

 

The All Other column in Note M includes our parent company expenses, other corporate charges and the operating results of BEM Services, Inc., a wholly owned subsidiary that provides administrative and financial oversight services to our other businesses on a cost-plus basis, and Zentrix Technologies Inc., a wholly owned subsidiary that manufactures electronic packages and other products. The All Other column shows an operating loss of $2.4 million in 2008 compared to an operating profit of $5.0 million in 2007. The change between years is due to a combination of the difference in litigation settlement gains between periods, increased corporate costs, lower charges out to the business units and other factors offset in part by reduced incentive compensation and the difference in the directors’ deferred compensation expense.

 

Advanced Material Technologies and Services

 

 

Advanced Material Technologies and Services manufactures precious, non-precious and specialty metal products, including vapor deposition targets, frame lid assemblies, clad and precious metal preforms, high temperature braze materials, ultra-fine wire, specialty inorganic materials, optics and performance coatings. Major markets for these products include data storage, medical and the wireless, semiconductor, photonic and hybrid sectors of the microelectronics market. An in-house refinery and metal cleaning operations allow for the reclaim of precious metals from internally generated or customers’ scrap. Due to the high cost of precious metal products, we emphasize quality, delivery performance and customer service in order to attract and maintain applications. Development of new products and new technologies is key for long-term growth. This segment has domestic facilities in New York, Connecticut, Wisconsin and California and international facilities in Asia and Europe.

 

Sales from Advanced Material Technologies and Services were $466.4 million in 2008, a decline of 10% from 2007, while sales of $519.9 million in 2007 were $176.5 million, or 51%, higher than sales of $343.4 million in 2006.

 

We adjust our selling prices daily to reflect the current cost of the precious and various non-precious metals sold. The cost of the metal is generally a pass-through to the customer and we generate a margin on our fabrication efforts irrespective of the type or cost of the metal used in a given application. Therefore, the cost and mix of metals sold will affect sales but not necessarily the margin dollars generated by those sales. The net increase in metal prices increased sales by an estimated $45.8 million in 2008 compared to 2007. The higher metal price pass-through offset a portion of the decline in sales due to lower underlying volumes. In 2007, metal prices on average were higher than in 2006, accounting for an estimated $29.7 million of the sales increase in that year compared to 2006.

 

The majority of the decline in sales in 2008 as well as the growth in sales in 2007 was due to ruthenium products manufactured by the Brewster, New York facility for media applications within the data storage market. Our product development efforts in recent years allowed us to capture a share of this growing market, particularly as customers were converting over to the perpendicular magnetic recording technology in late 2006 and the first half of 2007. However, after a quality issue and a change in material specifications, sales declined in the second half of 2007 from the first half of that year. The ramifications of these and other material supply issues continued and, along with weaker market demand in the second half of 2008 and falling prices, caused sales to decline in 2008.

 

Sales for media applications in 2008 were $141.9 million lower than in 2007. The total volume shipped, in terms of troy ounces, decreased 70% in 2008 from 2007, and was less than the decrease in the sales value. In addition to the lower volumes shipped, the sales value of shipments was also reduced in 2008 as a result of a shift in the material supply arrangements. In 2007, the majority of our media sales were manufactured from material we

purchased. In 2008, due to our customers’ high ruthenium inventory positions, the majority of these sales in 2008 were manufactured from customer-supplied metal on a toll basis, which reduced the quantity of metal invoiced to customers. We estimate that this trend toward using customer-supplied material accounted for $26.4 million of the reduction in media sales in 2008.

 

While media market sales declined in 2008, sales from other portions of this segment’s business were solid. Sales of vapor deposition targets, wire and other products into the wireless and photonic sectors of the microelectronics market improved significantly in 2008 and 2007 over the respective prior years; however, demand softened in the fourth quarter 2008 as key customers pushed orders out until 2009 in response to the slowdown in consumer spending.

 

Sales of lids from Thin Film Technology, Inc. (TFT), a wholly owned subsidiary, grew significantly in both 2008 and 2007; sales in 2008 were double the sales from 2006. This growth was fueled by strong demand from the defense and medical markets. Sales of inorganic chemicals and other materials from CERAC, incorporated (CERAC), a wholly owned subsidiary, had double-digit growth rates in each of the last two years. These materials are used in optics, solar energy and other applications.

 

The acquisition of Techni-Met added to the segment’s sales in 2008. Techni-Met manufactures precision precious metal coated flexible polymer films used primarily for medical applications. Prior to the acquisition, Techni-Met was a customer of ours, as they sourced the majority of their precious metal requirements from our Buffalo, New York operations. The acquisition allowed us to capture the value added generated by their operation. In addition, their technology provides potential long-term growth opportunities in various markets.

 

Advanced Material Technologies and Services generated gross margins of $58.0 million (12% of sales) in 2008, $100.7 million (19% of sales) in 2007 and $65.8 million (19% of sales) in 2006.

 

The $42.7 million decline in gross margin in 2008 from 2007 was caused largely by the lower sales volumes from the Brewster facility to the data storage market and the $15.2 million of lower of cost or market charges on ruthenium inventories. Margins were also lower in 2008 as a result of the previously discussed net $12.7 million benefit (the $22.9 million benefit from the sale of the low cost ruthenium inventory at higher market prices, the $4.5 million lower of cost or market charge and the $5.7 million quality charge) that flowed through this segment’s margins in 2007. Manufacturing overhead costs increased $12.7 million in 2008 over 2007 as a result of the expansion of several facilities, the addition of Techni-Met and other factors. Offsetting a portion of these unfavorable movements was a growth in margins from various portions of the business, including CERAC, TFT and the Buffalo operations. The acquisition of Techni-Met provided a margin benefit in 2008 as well.

 

Gross margin grew $34.9 million in 2007 over 2006. In addition to the net $12.7 million ruthenium benefits, margins improved $22.2 million in 2007 over 2006 due to the benefits of the higher sales volumes and a slight favorable change in the product mix partially offset by a $2.9 million increase in manufacturing overhead.

 

SG&A, R&D and other-net expenses from Advanced Material Technologies and Services were $47.7 million (10% of sales) in 2008, $41.3 million (8% of sales) in 2007 and $35.3 million (10% of sales) in 2006.

 

SG&A and R&D expenses incurred by Techni-Met totaled $2.1 million in 2008. International expenses grew $0.5 million in 2008 and $1.7 million in 2007 over the respective prior years as a result of increased activity and the creation of new overseas entities. Incentive compensation expense declined $1.5 million in 2008 due to the lower profitability while the incentive expense was $0.8 million higher in 2007 than in 2006. R&D costs increased in each of the last two years in order to support the current business and future growth. Domestic administrative costs have increased in each of the last two years in order to support the larger organization while corporate charges were higher in each year as well.

 

Amortization of intangible assets increased $2.4 million in 2008 over 2007 primarily as a result of the Techni-Met acquisition. Amortization was $0.1 million higher in 2007 than in 2006. Metal financing fees increased $2.5 million in 2008 due to the inclusion of Techni-Met and changes in the market value of the metal. Metal financing fees in 2007 were unchanged from 2006.

 

Operating profit from Advanced Material Technologies and Services was $10.3 million, a decline of $49.1 million from the profit of $59.4 million in 2007. The lower profit resulted primarily from the fall-off in

media market sales and the related ruthenium inventory issues. Operating profit in 2007 was $28.9 million higher than the profit of $30.5 million in 2006. Operating profit was 2% of sales in 2008, 11% in 2007 and 9% in 2006.

 

Specialty Engineered Alloys

 

 

Specialty Engineered Alloys manufactures and sells three main product families:

 

Strip products, the larger of the product families, include thin gauge precision strip and thin diameter rod and wire. These copper and nickel beryllium alloys provide a combination of high conductivity, high reliability and formability for use as connectors, contacts, switches, relays and shielding. Major markets for strip products include telecommunications and computer, automotive electronics, appliance and medical;

 

Bulk products are copper and nickel-based alloys manufactured in plate, rod, bar, tube and other customized forms that, depending upon the application, may provide superior strength, corrosion or wear resistance, thermal conductivity or lubricity. While the majority of bulk products contain beryllium, a growing portion of bulk products’ sales is from non-beryllium-containing alloys as a result of product diversification efforts. Applications for bulk products include plastic mold tooling, oil and gas drilling components, bearings, bushings, welding rods, and undersea telecommunications housing equipment; and,

 

Beryllium hydroxide is produced by Brush Resources Inc., a wholly owned subsidiary, at its milling operations in Utah from its bertrandite mine and purchased beryl ore. The hydroxide is used primarily as a raw material input for strip and bulk products and, to a lesser extent, by the Beryllium and Beryllium Composites segment. External sales of hydroxide from the Utah operations were less than 3% of Specialty Engineered Alloys’ total sales in each of the three most recent years.

 

Strip and bulk products are manufactured at facilities in Ohio and Pennsylvania and are distributed internationally through a network of company-owned service centers and outside distributors and agents.

 

Sales from Specialty Engineered Alloys of $299.9 million were $9.9 million, or 3%, higher than sales of $290.0 million in 2007 as a result of improved pricing and mix, the translation effect on foreign currency denominated sales and the pass through of higher metal prices. Sales in 2007 grew $14.4 million, or 5%, over sales of $275.6 million in 2006. The increase in sales in 2007 was largely due to an increase in the portion of sales subject to a metal price pass through and higher metal prices. Sales of bulk products increased in 2008 and 2007 while strip product sales declined in both 2008 and 2007 over the respective prior years.

 

Sales of bulk products to the industrial components market have increased in each of the last two years. This growth was due in part to higher shipments for oil and gas applications which were partially driven by higher energy prices. Demand from the oil and gas market slowed down in the fourth quarter 2008 as previously noted. The continued development of applications utilizing non-beryllium-containing alloys in the heavy equipment sector have contributed to the growth in shipments in 2008 and 2007 as well. Sales of materials for undersea telecommunications applications increased in 2008 as did sales for aerospace and defense applications.

 

Demand from the telecommunications and computer market for strip products, particularly for hand set applications, softened in 2007 and remained soft throughout 2008. Demand from the automotive market weakened approximately 10% in 2008 as compared to 2007 after being relatively flat in 2007 as compared to 2006. Sales into the appliance market, which is a smaller market for strip products, grew 6% in 2008 after growing 5% in 2007 over 2006.

 

Although total sales were higher in each of the last two years, volumes (i.e., pounds shipped) declined in both 2008 and 2007 from the respective prior year. Strip product shipment volumes declined 13% in 2008 from the 2007 level after declining 11% in 2007 from 2006. Shipments of both the higher beryllium-containing and lower-beryllium-containing strip products were down in each of the last two years while volumes of thin diameter rod and wire products increased modestly in each of the last two years. Bulk product shipment volumes improved 6% in 2008 over 2007 after growing 3% in 2007 over 2006.

Sales of new products contributed to the growth in Specialty Engineered Alloy sales in each of the last two years, including products for undersea telecommunications and homeland security.

 

The gross margin on sales by Specialty Engineered Alloys totaled $59.6 million in 2008, an improvement of $1.4 million over the gross margin of $58.2 million in 2007. The gross margin was 20% of sales in both years. In 2006, the gross margin was $65.9 million and 24% of sales.

 

The margin growth in 2008 was due to the benefits of the improved pricing and mix offset in part by the margin loss on the lower sales volume, higher costs of utilities, freight and certain chemicals and lower production volumes. The reduced gross margin in 2007 was caused partially by the lower sales volumes, an unfavorable change in the product mix and yield and performance and other manufacturing issues at the Elmore facility. These factors more than offset the benefits from the increased metal price pass-through as compared to 2006.

 

We increased the percentage of sales subject to the pass-through of changes in copper prices in the second half of 2006. The cost is passed on to customers based upon the cost at the time of receipt of the order. Over time, our selling price and purchase price are in balance, but timing differences between the receipt and actual fulfillment of the order can impact margins in a given period, especially when there is a significant movement in the market price of copper.

 

Total SG&A, R&D and net-other expenses grew $3.1 million from $50.7 million in 2007 to $53.8 million in 2008. Expenses were 18% of sales in 2008 and 17% of sales in 2007. In 2006, expenses totaled $57.9 million, or 21% of sales. The growth in expenses in 2008 was primarily due to higher foreign currency exchange losses, increased incentive compensation accruals and a higher bad debt expense. R&D efforts and expenses increased slightly as well. These higher costs were partially offset by lower corporate charges in 2008.

 

The $7.2 million decline in expenses in 2007 was due to a combination of lower incentive compensation and corporate charges and foreign currency losses. One-time costs associated with the closure of the New Jersey service center added $1.1 million to SG&A expenses in 2006.

 

Operating profit from Specialty Engineered Alloys declined $1.8 million from $7.6 million in 2007 to $5.8 million in 2008 as the increase in expenses more than offset the growth in gross margins. Operating profit was $7.9 million in 2006.

 

Beryllium and Beryllium Composites

 

 

Beryllium and Beryllium Composites manufactures beryllium-based metals and metal matrix composites in rod, sheet, foil and a variety of customized forms at the Elmore, Ohio and Fremont, California facilities. These materials are used in applications that require high stiffness and/or low density and they tend to be premium-priced due to their unique combination of properties. This segment also manufactures beryllia ceramics through Brush Ceramic Products Inc., a wholly owned subsidiary in Tucson, Arizona. Defense and government-related applications, including aerospace, is the largest market for Beryllium and Beryllium Composites, while other markets served include medical, telecommunications and computer, electronics (including acoustics), optical scanning, general industrial markets and automotive.

 

Sales from Beryllium and Beryllium Composites during 2007 and 2006 included shipments under two distinct, non-repeating programs — the James Webb Space Telescope (JWST) for NASA and the Joint European Torus

(JET), a nuclear fusion experimental reactor. A summary of the segment sales for these two projects, which were complete as of year-end 2007, and all other customers is as follows:

 

 

While total Beryllium and Beryllium Composites sales increased 5% in both 2008 and 2007, sales to all customers excluding the JWST and JET grew 11% in 2008 and 17% in 2007 over the respective prior years. This growth was largely due to increased demand from the defense market. Sales for defense platforms, mainly aerospace and missile systems, improved in the last three quarters of 2008 after a sluggish first quarter. Defense sales were strong throughout 2007 and the second half of 2006 after a weak first half of 2006. Sales for medical and industrial x-ray applications were down slightly in 2008 after increasing in 2007 over 2006. Sales for acoustic applications grew slightly in 2008 and this market represents a long-term growth opportunity for beryllium products. Sales of new products, including applications using near net shape technologies, also contributed to the sales growth in 2008 and 2007. Sales of ceramics improved 3% in 2008 over 2007 after declining 12% in 2007 from 2006.

 

Beryllium and Beryllium Composites generated a gross margin of $19.6 million (31% of sales) in 2008, $20.1 million (33% of sales) in 2007 and $18.7 million (32% of sales) in 2006. The decline in margins in 2008 as compared to 2007 resulted from an unfavorable product mix shift, due to the completion of the JWST and JET projects and increased sales for applications that typically carry lower margins, higher metal feedstock costs and an increase in manufacturing overhead costs partially offset by the margin benefit of the higher sales volume. The margin growth in 2007 over 2006 was due to the incremental margin generated by the higher sales volumes partially offset by an unfavorable change in the product mix.

 

SG&A, R&D and other-net expenses were $11.2 million (18% of sales) in 2008, $12.2 million (20% of sales) in 2007 and $11.3 million (20% of sales) in 2006. The decline in expenses in 2008 was due to lower incentive expense and corporate charges. Selling and other administrative costs were unchanged while R&D increased slightly as a result of higher activity levels. The growth in SG&A expenses in 2007 was partially due to additional costs to support the sales growth. Expenses also increased in 2007 and 2006 due to implementing a program to invest in people and processes that is designed to improve the timing, coordination and efficiency of the entire order fulfillment process, from application design to order placement to shipment and billing.

 

Operating profit from Beryllium and Beryllium Composites of $8.4 million in 2008 was a 7% improvement over the $7.8 million operating profit generated in 2007 as the reduction in incentive compensation and other expenses more than offset the lower gross margin. The profit in 2007 was $0.4 million higher than the 2006 operating profit. Operating profit was 13% of sales in each year presented.

 

Engineered Material Systems

 

 

Engineered Material Systems include clad inlay and overlay metals, precious and base metal electroplated systems, electron beam welded systems, contour profiled systems and solder-coated metal systems. These specialty strip metal products provide a variety of thermal, electrical or mechanical properties from a surface area or particular section of the material. Our cladding and plating capabilities allow for a precious metal or brazing alloy to be applied to a base metal only where it is needed, reducing the material cost to the customer as well as providing design flexibility. Major applications for these products include connectors, contacts and semiconductors. The largest markets for Engineered Material Systems are automotive electronics, telecommunications and computer

electronics and data storage. The energy and defense and medical electronic markets are smaller but offer further growth opportunities. Engineered Material Systems are manufactured at our Lincoln, Rhode Island facility.

 

Engineered Material Systems’ sales of $65.9 million in 2008 declined 7% from sales of $70.9 million in 2007. Sales in 2007 improved 3% over sales in 2006. The lower sales in 2008 were primarily due to weak demand from the automotive electronics market. Improved demand from the European automotive market in the first half of 2008 had helped to offset a portion of the weakness in the U.S. market, but the European market weakened in the second half of the year. The automotive electronics market was weaker in 2007 than in 2006 as well.

 

Sales of materials for disk drive applications, which were strong during the first three quarters of 2008, softened in the fourth quarter 2008 and were essentially unchanged for the full year 2008 compared to 2007. Sales of this new product in 2007 were more than double the sales in 2006 and were the main contributor to the sales growth for this segment in 2007. Sales of other new products, including fuses and switches, and sales for new applications in the energy and medical markets also grew in each of the last two years over the respective prior periods.

 

Engineered Material Systems generated a gross margin on sales of $13.5 million in 2008 compared to $13.0 million in 2007 and $11.3 million in 2006. As a percent of sales, gross margin improved to 21% of sales in 2008 from 18% in 2007 and 17% in 2006. The margin grew in 2008 despite the lower sales due to reduced manufacturing and commodity costs. In addition, yields and other manufacturing efficiencies improved beginning in the fourth quarter 2007 and continued during 2008. A portion of these manufacturing improvements resulted from recent capital investments. The higher sales and a favorable change in the product mix in 2007 contributed to the margin growth in that year as well.

 

SG&A, R&D and other-net expenses from Engineered Material Systems declined $0.7 million in 2008 from 2007 after declining $0.3 million in 2007 from 2006. The decline in expenses in 2008 was due to lower incentive compensation expense and corporate charges. Legal and administrative costs were lower in 2007 than in 2006. In 2006, these costs were higher due to efforts to develop a joint venture in China; we decided not to pursue this effort any further early in the first quarter 2007. Incentive compensation costs were higher in 2007 than 2006, but this increase was largely offset by lower corporate charges.

 

Operating profit generated by Engineered Material Systems improved to $5.9 million (9% of sales) in 2008 from $4.7 million (7% of sales) in 2007. Operating profit in 2007 was a $2.0 million improvement over the profit of $2.7 million (4% of sales) earned in 2006.

 

International Sales and Operations

 

We operate in worldwide markets and our international customer base continues to expand due to the development of various foreign nations’ economies and the relocation of U.S. businesses overseas. Our international operations are designed to provide a cost-effective method of capturing the growing overseas demand for our products.

 

The Advanced Material Technologies and Services segment has operations in Singapore, Taiwan, the Philippines and Ireland and recently constructed facilities in China and the Czech Republic. These facilities provide a combination of light manufacturing, finishing operations and distribution services.

 

Brush International has service centers in Germany, England, Japan and Singapore that primarily focus on the distribution of materials from Specialty Engineered Alloys while also providing additional local support to portions of our other businesses.

 

We also have branch sales offices and other operations in various countries, including the Republic of China, Korea and Taiwan, and we utilize an established network of independent distributors and agents throughout the world.

Total international sales, including sales from international operations as well as direct exports from the U.S., were as follows:

 

 

The international sales presented in the above table are included in individual segment sales figures previously discussed. The majority of international sales are to the Pacific Rim, Europe and Canada.

 

After growing 73% in 2007 over 2006, Asian sales declined 34% in 2008 from 2007. Both the decline in 2008 and the growth in 2007 were primarily due to ruthenium product sales to the media market. International sales outside of Asia grew slightly in 2008 and 2007 over the respective prior periods.

 

Telecommunications and computer, data storage and automotive electronics are the largest international markets for our products. The appliance market for Specialty Engineered Alloys is a more significant market, primarily in Europe, than it is domestically while government and defense applications are not as prevalent overseas as they are in the U.S. Our market share is smaller in the overseas markets than it is domestically and, given the macro-economic growth potential for the international economies, including the continued transfer of U.S. business to overseas locations, the international markets may present greater long-term growth opportunities. We believe that a large portion of the long-term international growth will come from Asia.

 

Sales from the European and certain Asian operations are denominated in the local currency. Exports from the U.S. and the balance of the sales from the Asian operations are typically denominated in U.S. dollars. Local competition generally limits our ability to adjust selling prices upwards to compensate for short-term unfavorable exchange rate movements. In 2008, the dollar’s value fluctuated significantly against the currencies in which we sell, but on average, it was weaker than in 2007; the dollar was also weaker on average in 2007 than it was in 2006. The favorable effect on the translation of foreign currency sales was $8.0 million in 2008 as compared to 2007 and $4.1 million in 2007 as compared to 2006.

 

We have a hedge program with the objective of minimizing the impact of fluctuating currency values on our consolidated operating profit. See Critical Accounting Policies.

 

Legal Proceedings

 

One of our subsidiaries, Brush Wellman Inc., is a defendant in proceedings in various state and federal courts brought by plaintiffs alleging that they have contracted chronic beryllium disease or other lung conditions as a result of exposure to beryllium. Plaintiffs in beryllium cases seek recovery under negligence and various other legal theories and seek compensatory and punitive damages, in many cases of an unspecified sum. Spouses, if any, claim loss of consortium.

 

The following table summarizes the associated activity with beryllium cases.

 

 

Settlement payment and dismissal for a single case may not occur in the same period.

Additional beryllium claims may arise. Management believes that we have substantial defenses in these cases and intends to contest the suits vigorously. Employee cases, in which plaintiffs have a high burden of proof, have historically involved relatively small losses to us. Third-party plaintiffs (typically employees of customers or contractors) face a lower burden of proof than do employees or former employees, but these cases are generally covered by varying levels of insurance.

 

Although it is not possible to predict the outcome of the litigation pending against our subsidiaries and us, we provide for costs related to these matters when a loss is probable and the amount is reasonably estimable. Litigation is subject to many uncertainties, and it is possible that some of these actions could be decided unfavorably in amounts exceeding our reserves. An unfavorable outcome or settlement of a pending beryllium case or additional adverse media coverage could encourage the commencement of additional similar litigation. We are unable to estimate our potential exposure to unasserted claims.

 

Based upon currently known facts and assuming collectibility of insurance, we do not believe that resolution of the current and future beryllium proceedings will have a material adverse effect on our financial condition or cash flow. However, our results of operations could be materially affected by unfavorable results in one or more of these cases. As of December 31, 2008, two purported class actions were pending.

 

The balances recorded on the Consolidated Balance Sheets associated with beryllium litigation were as follows:

 

 

The reserve and the recoverable changed by equal amounts in 2008 due to changes in the outstanding cases. There were no settlement payments made by our insurers or us during 2008 for beryllium litigation.

 

Regulatory Matters.  Standards for exposure to beryllium are under review by OSHA and by other governmental and private standard-setting organizations. One result of these reviews will likely be more stringent worker safety standards. Some organizations, such as the California Occupational Health and Safety Administration and the American Conference of Governmental Industrial Hygienists, have adopted standards that are more stringent than the current standards of OSHA. The development, proposal or adoption of more stringent standards may affect buying decisions by the users of beryllium-containing products. If the standards are made more stringent and/or our customers or other downstream users decide to reduce their use of beryllium-containing products, our results of operations, liquidity and financial condition could be materially adversely affected. The impact of this potential adverse effect would depend on the nature and extent of the changes to the standards, the cost and ability to meet the new standards, the extent of any reduction in customer use and other factors. The magnitude of this potential adverse effect cannot be estimated.

 

FINANCIAL POSITION

 

Working Capital

 

Net cash from operations was $76.8 million in 2008, an improvement of $25.9 million over the cash flow from operations of $50.9 million in 2007. Cash flow from operations was $38.8 million in 2006. In each of the last three years, cash flow from operations was stronger in the second half of the year than it was in the first half. Cash flow from operations in the second half of 2008 was $70.7 million, or 92% of the total for the year. Cash flow from operations in 2008 improved over 2007 despite the decline in net income as a result of changes in working capital levels and the benefits of depreciation and amortization.

 

As previously noted, changes in the cost of precious and base metals are essentially passed on to customers. Therefore, while sudden movements in the price of metals can cause a temporary imbalance in our cash receipts and payments in either direction, once prices stabilize our cash flow tends to stabilize as well.

Cash balances totaled $18.5 million at year-end 2008 compared to $31.7 million at year-end 2007. A portion of the cash on hand, increased borrowings and the cash flow from operations were used to fund the acquisition of Techni-Met, capital expenditures and the repurchase of shares during 2008. Cash increased $16.1 million in 2007 as the cash flow from operations coupled with the proceeds from the exercise of stock options were more than enough to fund capital expenditures and reduce debt in that year.

 

Accounts receivable of $89.8 million at December 31, 2008 was $7.6 million, or 8%, below the receivable balance of $97.4 million at year-end 2007. The decreased balance in 2008 was mainly due to the lower sales volume in the fourth quarter. However, receivables did not decline proportionately with the change in sales as the days sales outstanding (DSO), a measure of the average time period to collect receivables, slowed down approximately five days as of the end of the 2008 from the end of 2007. The increased DSO in 2008 was still within the normal historical range of our collection period.

 

Accounts written off to bad debt expense increased in 2008 over the prior year but write-offs remained relatively minor. The increase was largely due to the bankruptcy filing of one customer who purchased scrap from one of our operations. We closely monitor our accounts receivable aging and revise the credit terms offered to our customers as conditions warrant in order to minimize our exposure.

 

Accounts receivable grew $10.9 million, or 13%, in 2007 as a result of higher sales volumes as the DSO improved approximately one day in 2007 over year-end 2006.

 

Inventories totaled $156.7 million as of year-end 2008, a decrease of $8.5 million, or 5%, from the balance of $165.2 million as of year-end 2007. Inventory turns, a measure of how efficiently inventory is utilized, slowed down approximately 10% at year-end 2008 from year-end 2007. We reduced inventories approximately 11% in the fourth quarter 2008 from the levels at the end of the third quarter 2008 as a result of the slowdown in business.

 

Inventories at the Brewster facility within the Advanced Material Technologies and Services segment declined in response to the lower sales volumes and as a result of the $15.2 million lower of cost or market adjustment. This decline was partially offset by an increase in inventories within the Specialty Engineered Alloys segment. Those inventories grew approximately 13% in 2008 due to increased mining activity at the Utah operations and as a result of additional purchases of copper late in the fourth quarter to allow for portions of the production activity at the Elmore facility to be campaigned for scheduling and efficiency purposes in the fourth quarter 2008 and first quarter 2009.

 

The inventory balance at year-end 2007 was 9% higher than inventories at the prior year-end. Despite the growth in the inventory balance, inventory turns improved in 2007. The majority of the increase in inventories in 2007 was in Advanced Material Technologies and Services. This segment maintains the majority of its precious metals on off-balance sheet arrangements. However, a significant portion of its sales growth in 2007 was in products that use other metals that are owned and not held on consignment, including ruthenium.

 

The decline in the cost of copper, nickel and various precious metals reduced the value of inventory on a first-in, first-out (FIFO) basis in 2008 while the higher cost of gold increased the value of inventory on a FIFO basis. In 2007, the inventory value of these metals increased on a FIFO basis due to higher metal prices. The impact of the changing metal prices was partially offset by the use of the last-in, first-out (LIFO) valuation method for these metals, limiting the impact on the fluctuation in inventory carrying value on the balance sheet as the LIFO process will result in the current prices being charged to the income statement. See Critical Accounting Policies.

 

Prepaid expenses, including insurance, income taxes, property taxes, rent, manufacturing supplies and other items, totaled $23.7 million as of year-end 2008, an increase of $6.0 million over the balance of $17.7 million as of year-end 2007. The increase was primarily due to income taxes. Prepaid income taxes, which represent overpayments of taxes to be refunded or applied to the 2009 liability, totaled $4.5 million at December 31, 2008; there was no prepaid income tax balance at December 31, 2007 as we were in a tax liability position and did not have an overpayment. Prepaid expenses also grew in 2008 due to changes in the fair value of euro and sterling derivative contracts. Prepaid expenses increased $3.7 million in 2007 over the balance at the prior year end.

 

Other assets were $34.4 million at year-end 2008, an increase of $22.6 million over the balance of $11.8 million at year-end 2007. This increase was primarily due to the intangible assets acquired with Techni-

Met as well as an increase to the insurance recoverable account offset in part by the amortization of the existing and acquired intangible assets. Other assets declined $1.8 million in 2007 primarily as a result of the amortization of intangible assets. The insurance recoverable account was also reduced as a result of the legal settlement in the fourth quarter and other changes to the individual outstanding cases during the year.

 

Accounts payable of $28.0 million as of December 31, 2008 was $0.9 million higher than the prior year-end balance of $27.1 million while the 2007 balance was $3.6 million lower than 2006 year-end. The change in balances between years was primarily due to the timing of payments.

 

Accrued salaries and wages declined $11.6 million in 2008 from 2007 after growing $2.1 million in 2007 over the 2006 year-end level. The changes in the balance in both years were due to changes in the incentive compensation accruals, manpower levels and other related factors.

 

Unearned revenue, which is a liability representing billings to customers in advance of the shipment of product, was $0.1 million as of December 31, 2008 and $2.6 million as of December 31, 2007.

 

Other long-term liabilities were $19.4 million as of year-end 2008 compared to $11.6 million at year-end 2007. Long-term unearned income increased $8.0 million in 2008 and $3.5 million in 2007 for reimbursements under a government funded capital expenditure program. See Critical Accounting Policies. Other increases in 2008, including an increase to the legal reserve and rent accruals, were offset by a reduction to the long-term portion of the incentive compensation accrual.

 

Total other long-term liabilities were unchanged in 2007 from the year-end 2006 balance. The increase in unearned income in 2007 was offset by reductions in the long-term incentive compensation accrual, due to a portion of the accrual becoming a current liability, and the legal reserve. The legal reserve declined in 2007 as a result of cases being dismissed and the payment of $0.1 million for settlements.

 

Depreciation and Amortization

 

Depreciation, amortization and depletion was $33.8 million in 2008, $23.9 million in 2007 and $24.6 million in 2006. The increase in expense in 2008 was due in part to additional mine activity at our Utah operations and the acquisition of intangible assets as part of the Techni-Met purchase.

 

Capital Expenditures

 

Capital expenditures for property, plant and equipment and mine development totaled $35.9 million in 2008, $33.6 million in 2007 and $15.5 million in 2006. Capital spending has exceeded the level of depreciation in each of the last two years as we increased the level of capital investment in order to expand our operations, improve efficiencies, implement new technologies and upgrade or replace older equipment.

 

Capital spending by Advanced Material Technologies and Services totaled $7.8 million in 2008 and $10.3 million in 2007. We expanded the Brewster facility to accommodate the potential growth in the production of targets during this time period. We also constructed a new facility in China during 2008 and 2007 while the Wheatfield, New York facility was expanded in order to accommodate the addition of shield kit cleaning equipment in 2007. Spending in both years also included the implementation of a new software system.

 

Specialty Engineered Alloys capital spending was $9.1 million in 2008 and $12.5 million in 2007. Included in these totals are mine development costs of $0.4 million in 2008 and $7.1 million in 2007 as we completed and opened a new pit for mining bertrandite ore in Utah during 2008. Various discrete pieces of equipment at the Ohio and Pennsylvania facilities were upgraded or replaced in each of the last two years.

 

Spending within Engineered Material Systems totaled $1.1 million in 2008 and $3.0 million in 2007. The installation of a new efficient high technology work center at the Lincoln facility, which began in 2007, was completed in 2008.

 

Capital spending in 2008 included $11.8 million for the design and development of the new facility for the production of primary beryllium under a Title III contract with the U.S. Department of Defense (DOD). The total cost of the project is estimated to be approximately $90.4 million; we will contribute land, buildings, research and

development, technology and ongoing operations valued at approximately $23.3 million to the project. The DOD will reimburse us for the balance of the project cost. All of the funds required to complete the project are in the President’s approved defense budget, but are still subject to final House and Senate appropriations approvals. Reimbursements from the DOD are recorded as unearned income and included in other long-term liabilities on the Consolidated Balance Sheets. We began construction of the facility early in the third quarter 2008 and we anticipate it will be completed in the fourth quarter 2010. Since 2000, all of our metallic beryllium requirements have been supplied from materials purchased from the National Defense Stockpile and international vendors. Successful completion of this project will allow for the creation of the only domestic facility capable of producing primary beryllium.

 

Approximately 56% of the capital spending in 2008 was for expansion purposes. Included in this figure is the spending on the new primary beryllium facility that is being reimbursed by the DOD. Spending on new technology projects accounted for an estimated 18% while maintenance capital totaled an estimated 26% of the total spending.

 

In addition to the above capital expenditure totals, we acquired the operating assets of Techni-Met for $87.5 million in the first quarter 2008. We received $1.4 million from escrow in the first quarter 2009 as the final purchase adjustment under the terms of the agreement; the $1.4 million was recorded in other receivables on the December 31, 2008 Consolidated Balance Sheet. Subsequent to the acquisition, we sold the precious metal portion of Techni-Met’s inventory for its fair value of $22.9 million to a financial institution and consigned it back under our existing consignment lines. Goodwill assigned to the transaction totaled $13.9 million.

 

We acquired the stock of CERAC in the first quarter 2006 for $25.7 million, net of cash received. Goodwill assigned to the CERAC acquisition totaled $8.7 million.

 

Retirement and Post-employment Benefits

 

The liability for retirement and post-employment benefits increased from $57.5 million at December 31, 2007 to $97.2 million at December 31, 2008 largely due to a change in the valuation of the domestic defined benefit pension plan.

 

The projected benefit obligation for this plan, which covers the majority of our domestic employees, was $137.5 million as of year-end 2008 compared to $124.2 million at year-end 2007. The market value of the plan assets was $78.8 million as of year-end 2008, a decline of $28.3 million from year-end 2007 due to actual investment losses of $26.6 million and benefit and expense payments totaling $6.0 million offset in part by Company contributions of $4.3 million.

 

The liability for the domestic defined benefit pension recognized on the Consolidated Balance Sheets was $58.7 million as of December 31, 2008 and $17.0 million as of December 31, 2007. In the fourth quarter 2008, we increased the pension liability and recorded a $41.5 million pre-tax charge to other comprehensive income (OCI), a component of shareholders’ equity, primarily as a result of the plan performance in 2008 as well as a change in the discount rate.

 

Brush International’s subsidiary in Germany has an unfunded retirement plan for its employees while its subsidiary in England has a funded retirement plan. See Note I to the Consolidated Financial Statements for additional details.

 

A portion of our retirees and current employees are eligible to participate in a retiree medical benefit plan. The liability for this plan, which is unfunded, was $32.8 million at December 31, 2008 and $34.2 million at December 31, 2007. The plan expense was $2.4 million in 2008 and $2.2 million in 2007.

 

Debt

 

Total outstanding debt of $41.8 million as of year-end 2008 was $6.3 million higher than the outstanding debt as of year-end 2007. Short-term debt of $30.6 million, which consisted of a gold-denominated loan and foreign currency denominated loans, increased $5.7 million during 2008. Long-term debt increased $0.6 million during 2008 and stood at $11.2 million as of year-end 2008. Mandatory long-term debt repayments in 2009 total

$0.6 million. Debt increased in the first quarter 2008 primarily due to the acquisition of Techni-Met and then decreased each quarter over the balance of the year as a result of the cash flow from operations.

 

We negotiated a new $240.0 million revolving credit agreement in the fourth quarter 2007. This committed facility matures in the fourth quarter 2012 and is comprised of sub-facilities for revolving loans, swing line loans, letters of credit and foreign currency denominated borrowings. We were in compliance with all of our debt covenants as of December 31, 2008.

 

Outstanding debt totaled $35.5 million as of December 31, 2007, a decrease of $13.5 million from the $49.0 million balance at the prior year-end. Short-term debt of $24.9 million declined $3.2 million during 2007 while long-term debt of $10.6 million declined $10.3 million during 2007 as a result of the pay down of borrowings under the revolving credit agreement and the pay-off of the $0.8 million Utah variable rate promissory note.

 

Shareholders’ Equity

 

Shareholders’ equity totaled $347.1 million as of year end 2008, a decrease of $6.6 million from the balance of $353.7 million at year end 2007. Equity increased $62.7 million during 2007. Comprehensive income (loss), which includes net income, changes in derivative fair values and the pension liability that are charged directly to equity and other factors, was a main cause for the change in equity in both years. Comprehensive income (loss) was $(4.9) million in 2008 and $52.0 million in 2007. See Note L to the Consolidated Financial Statements.

 

We received $0.2 million of cash for the exercise of approximately 12,000 options in 2008. We received $5.0 million for the exercise of approximately 296,000 stock options in 2007. The decline in the number of options exercised in 2008 as compared to 2007 was primarily due to the lower share price on average throughout 2008.

 

In the third quarter 2008, our Board of Directors adopted a share buyback program authorizing the repurchase of up to one million shares of stock. The primary purpose of the program is to offset the dilution caused by stock-based compensation plans. As of year-end 2008, we had repurchased 300,000 shares at a cost of $5.0 million under this plan.

 

We adopted FASB Interpretation No. 48, “Accounting for Uncertainties in Income Taxes, an interpretation of FASB Statement No. 109” (FIN 48) as of January 1, 2007. FIN 48 provides guidance on the financial statement recognition, measurement, treatment and disclosure of a tax position taken or expected to be taken on a tax return as well as the associated interest and penalties. As a result of adopting FIN 48, we increased our accrued income tax payable by $1.4 million with the offset recorded as a charge against retained earnings as of January 1, 2007. Prior-year results were not restated for the adoption of FIN 48.

 

Equity was also affected by stock-based compensation expense, the tax benefits on the exercise of options and other factors in both 2008 and 2007.

 

Off-balance Sheet Obligations

 

We maintain the majority of our precious metal inventories on a consignment basis in order to reduce our exposure to metal price movements and to reduce our working capital investment. See Quantitative and Qualitative Disclosures About Market Risk. The notional value of the off-balance sheet inventory was $104.2 million at December 31, 2008 compared to $71.2 million at December 31, 2007. This increase in value was due to an increase in the quantity on hand, largely as a result of the Techni-Met acquisition, and higher gold prices offset in part by lower prices for platinum, palladium and silver. The unused and available capacity under the consignment lines totaled approximately $70.3 million as of year-end 2008.

Contractual Obligations

 

A summary of payments to be made under long-term debt agreements and operating leases, pension plan contributions and material purchase commitments by year is as follows:

 

 

Consistent with our prior practice, we anticipate that we will renegotiate a new debt agreement prior to the maturation of the current revolving credit agreement in 2012. Outstanding borrowings under the revolving credit agreement totaled $2.3 million as of December 31, 2008. See Note F to the Consolidated Financial Statements for additional debt information. The lease payments represent payments under non-cancelable leases with initial lease terms in excess of one year as of December 31, 2008. See Note G to the Consolidated Financial Statements for further leasing details.

 

The pension plan contribution of $18.3 million in the above table refers to the domestic defined benefit plan. Contributions to the plan are designed to comply with ERISA guidelines and are based upon the plan’s funded ratio, which is affected by actuarial assumptions, investment performance, benefit payouts, plan expenses, amendments and other factors. Therefore, it is not practical to estimate contributions to the plan beyond one year. The amount shown in the table represents our best estimate of the 2009 contribution as of early in 2009.

 

The purchase commitments of $1.4 million are for capital equipment to be acquired in 2009.

 

Other

 

We believe that cash flow from operations plus the available borrowing capacity and the current cash balance are adequate to support operating requirements, capital expenditures, projected pension plan contributions, environmental remediation projects and strategic acquisitions.

 

Cash flow from operations has grown in each of the last three years over the respective prior year, aggregating $166.5 million and more than doubling the total capital expenditures and mine development costs in that same period.

 

A summary of the outstanding debt, cash balances and available borrowing capacity as of the end of each of the last three years is as follows:

 

 

Debt net of cash is a non-GAAP measure. We are providing this information because we believe it is more indicative of our financial position.

 

As the chart indicates, debt net of cash declined $10.1 million from the end of 2006 to the end of 2008. The reduction in debt net of cash resulted from the cash from operations and, to a lesser extent, cash received from the exercise of stock options. During this time period, we acquired Techni-Met for a net outlay of $63.1 million (the purchase price less the cash received for the sale of their gold against the consignment line).

 

The available borrowing capacity in the chart represents the amounts that could be borrowed under the revolving credit agreement and other secured lines existing as of December 31 of each year depicted. The applicable

debt covenants have been taken into account when determining the available borrowing capacity. The borrowing capacity was higher in 2008 and 2007 than in 2006 largely because of the improved terms provided by the credit agreement signed in the fourth quarter 2007.

 

The current revolving credit agreement provides more flexible covenants and terms than the prior agreement. The most restrictive covenant is a fixed charge coverage ratio. The agreement also limits the borrowings to a multiple of earnings before interest, taxes, depreciation and amortization and other adjustments.

 

The debt-to-total-debt-plus-equity ratio, a measure of balance sheet leverage, increased to 11% as of December 31, 2008 from 9% as of December 31, 2007. The ratio had improved in each of the previous two years. This level of leverage is still below the long-term average for the Company.

 

The working capital ratio, which compares current assets excluding cash to current liabilities excluding debt, improved each of the last two years, growing from 3.0 to 1.0 as of year-end 2006 to 3.4 to 1.0 as of year-end 2007 to 3.8 to 1.0 as of year-end 2008.

 

Portions of the cash balances may be invested in high quality, highly liquid investments with maturities of three months or less.

 

ENVIRONMENTAL

 

We have an active program of environmental compliance. We estimate the probable cost of identified environmental remediation projects and establish reserves accordingly. The environmental remediation reserve balance was $6.3 million at December 31, 2008 and $5.2 million at December 31, 2007. The main cause for the increase in the accrual in 2008 was for clean-up costs for the Company’s former headquarter building that previously was also used to house light manufacturing operations and R&D laboratories. There were no new significant remediation projects identified during 2007. Payments against the reserve totaled $0.3 million in 2008 and $0.1 million in 2007. See Note J to the Consolidated Financial Statements.

 

ORE RESERVES

 

Brush Resources’ reserves of beryllium-bearing bertrandite ore are located in Juab County, Utah. An ongoing drilling program has generally added to proven reserves. Proven reserves are the measured quantities of ore commercially recoverable through the open-pit method. Probable reserves are the estimated quantities of ore known to exist, principally at greater depths, but prospects for commercial recovery are indeterminable. Ore dilution that occurs during mining is approximately seven percent. Approximately 87% of beryllium in ore is recovered in the extraction process. We augment our proven reserves of bertrandite ore through the purchase of imported beryl ore. This ore, which is approximately 4% beryllium, is also processed at Brush Resources’ Utah extraction facility.

 

We use computer models to estimate ore reserves, which are subject to economic and physical evaluation. Development drilling can also affect the total ore reserves to some degree. The requirement that reserves pass an economic test causes open-pit mineable ore to be found in both proven and probable geologic settings. Proven reserves have decreased slightly in each of the last four years while probable reserves have remained unchanged over the same time period. We own approximately 95% of the proven reserves, with the remaining reserves leased.

Based upon average production levels in recent years, proven reserves would last approximately one hundred years. Ore reserves classified as possible are excluded from the following table.

 

 

CRITICAL ACCOUNTING POLICIES

 

The preparation of financial statements requires the inherent use of estimates and management’s judgment in establishing those estimates. The following are the most significant accounting policies we use that rely upon management’s judgment.

 

Accrued Liabilities.  We have various accruals on our balance sheet that are based in part upon management’s judgment, including accruals for litigation, environmental remediation and workers’ compensation costs. We establish accrual balances at the best estimate determined by a review of the available facts and trends by management and independent advisors and specialists as appropriate. Absent a best estimate, the accrual is established at the low end of the estimated reasonable range in accordance with Statement No. 5, “Accounting for Contingencies”. Litigation and environmental accruals are only established for identified and/or asserted claims; future claims, therefore, could give rise to increases to the accruals. The accruals are adjusted as facts and circumstances change. The accruals may also be adjusted for changes in our strategies or regulatory requirements. Since these accruals are estimates, the ultimate resolution may be greater or less than the established accrual balance for a variety of reasons, including court decisions, additional discovery, inflation levels, cost control efforts and resolution of similar cases. Changes to the accruals would then result in an additional charge or credit to income. See Note J to the Consolidated Financial Statements.

 

Certain legal claims are subject to partial or complete insurance recovery. The accrued liability is recorded at the gross amount of the estimated cost and the insurance recoverable, if any, is recorded as an asset and is not netted against the liability. The accrued legal liability includes the estimated indemnity cost only, if any, to resolve the claim through a settlement or court verdict. The legal defense costs are not included in the accrual and are expensed in the period incurred, with the level of expense in a given year affected by the number and types of claims we are actively defending.

 

The enhanced insurance coverage included in the litigation settlement with our insurers in the fourth quarter 2007 provides for coverage of non-employee claims for beryllium disease made prior to year-end 2022 where any portion of the alleged exposure period is prior to year-end 2007. This occurrence-based coverage insures claims from various prior years where we previously had little or sometimes no coverage. The insurance covers defense costs and indemnity payments and is subject to a $1.0 million annual deductible. In 2008, defense costs exceeded the $1.0 million deductible by an immaterial amount.

 

Pensions.  We have a defined benefit pension plan that covers a large portion of our current and former domestic employees. We account for this plan in accordance with Statement No. 158. Under this statement, the carrying values of the associated assets and liabilities are determined on an actuarial basis using numerous actuarial and financial assumptions. Differences between the assumptions and current period actual results may be deferred into the net pension asset or liability value and amortized against future income under established guidelines. The deferral process generally reduces the volatility of the recognized net pension asset or liability and current period income or expense. Unrealized gains or losses are recorded in OCI. The actuaries adjust certain assumptions to reflect changes in demographics and other factors, including mortality rates and employee turnover, as warranted.

Management annually reviews other key assumptions, including the expected return on plan assets, the discount rate and the average wage rate increase, against actual results, trends and industry standards and makes adjustments accordingly. These adjustments may then lead to a higher or lower expense in a future period.

 

We establish the discount rate used to determine the present value of the projected and accumulated benefit obligation at the end of each year based upon the available market rates for high quality, fixed income investments. An increase to the discount rate would reduce the present value of the projected benefit obligation and future pension expense and, conversely, a lower discount rate would raise the benefit obligation and future pension expense. We elected to use a discount rate of 6.15% as of December 31, 2008 compared to a rate of 6.50% as of December 31, 2007.

 

Our pension plan investment strategies are governed by a policy adopted by the Retirement Plan Review Committee of the Board of Directors. The future return on pension assets is dependent upon the plan’s asset allocation, which changes from time to time, and the performance of the underlying investments. As a result of our review of various factors, we maintained the expected rate of return on plan asset assumption at 8.25% as of December 31, 2008, unchanged from December 31, 2007. While the pension plan investments generated a loss in 2008, the expected rate of return assumption relates to the long term and we believe that an 8.25% return over the long term is reasonable. Should the assets earn an average return less than 8.25% over time, in all likelihood the future pension expense would increase. Investment earnings in excess of 8.25% would tend to reduce the future expense.

 

The investment loss on the defined benefit plan in 2008 was caused by the global economic crisis and the resulting severe decline in the stock market. In accordance with accounting guidelines, this loss was deferred and will be amortized to expense over a number of years. As of early in the first quarter 2009, we estimate that the amortization of this deferred loss along with other net valuation gains and losses, the change in the discount rate, the lower asset value and other factors should result in a $0.5 million increase in the expense for this plan in 2009 over 2008.

 

If the expected rate of return assumption was changed by 25 basis points (0.25%) and all other pension assumptions remained constant, the 2009 projected pension expense would change by approximately $0.3 million. If the December 31, 2008 discount rate were reduced by 25 basis points and all other pension assumptions remained constant, then the 2009 projected pension expense would increase by approximately $0.5 million.

 

Cash contributions and funding requirements are governed by ERISA and IRS guidelines and not by Statement No. 158. These guidelines are subject to change from time to time. As previously indicated, based upon these guidelines, current assumptions and estimates and our pension plan objectives, we estimate a cash contribution of approximately $18.3 million will be made in 2009.

 

The pension liability under Statement No. 158 will be recalculated at the measurement date (December 31 of each year) and any adjustments to this account and other comprehensive income within shareholders’ equity will be recorded at that time accordingly. See Note I to the Consolidated Financial Statements for additional details on our pension and other retirement plans.

 

LIFO Inventory.  The prices of certain major raw materials that we use, including copper, nickel, gold, silver and other precious metals, fluctuate during a given year. As noted, gold prices increased in each of the last three years while prices for copper, nickel and the majority of the other precious metals we use declined in 2008 after increasing in each of the prior two years. Where possible, such changes in costs are generally reflected in selling price adjustments. The prices of labor and other factors of production, including supplies and utilities, generally increase with inflation. From time to time, we will revise our billing practices to include an energy surcharge in attempts to recover a portion of our higher energy costs from our customers. However, market factors, alternative materials and competitive pricing may limit our ability to offset cost increases with higher prices.

 

We use the LIFO method for costing the majority of our domestic inventories. Under the LIFO method, inflationary cost increases are charged against the current cost of goods sold in order to more closely match the cost with the associated revenue. The carrying value of the inventory is based upon older costs and as a result, the LIFO cost of the inventory on the balance sheet is typically, but not always, lower than it would be under most alternative costing methods. The LIFO cost may also be lower than the current replacement cost of the inventory. The LIFO

inventory value tends to be less volatile during years of fluctuating costs than the value would be using other costing methods.

 

The LIFO impact on the income statement in a given year is dependent upon the inflation rate effect on raw material purchases and manufacturing conversion costs, the level of purchases in a given year and changes in the inventory mix and quantities. Assuming no change in the quantity or mix of inventory from the December 31, 2008 level, a 100 basis point change in the annual inflation rate would cause a $0.5 million change in the LIFO inventory value.

 

Deferred Tax Assets.  We record deferred tax assets and liabilities in accordance with Statement No. 109, “Accounting For Income Taxes”. The deferrals are determined based upon the temporary difference between the financial reporting and tax bases of assets and liabilities. We review the expiration dates of the deferrals against projected income levels to determine if the deferral will or can be realized. If it is determined that it is more likely than not that a deferral will not be realized, a valuation allowance would be established for that item. Certain deferrals, including the alternative minimum tax credit, do not have an expiration date. See Note P to the Consolidated Financial Statements for additional deferred tax details.

 

We will also evaluate deferred tax assets for impairment due to cumulative operating losses and record a valuation allowance as warranted. A valuation allowance was recorded in 2002 as a result of the cumulative operating losses at that time. The valuation allowance was adjusted in subsequent years before being fully reversed in the fourth quarter 2006, except for an immaterial amount associated with one international operation, as we determined it was more likely than not that we would utilize substantially all of our deferred tax assets based upon current and projected earnings.

 

The reversal of the valuation allowance in 2006 resulted in a tax benefit rather than a tax expense being recorded against income before income taxes in that year. Tax expense was recorded in 2007 and 2008 at the effective tax rate without a net adjustment for any material movement in a valuation allowance.

 

Unearned revenue.  Billings under long-term sales contracts in advance of the shipment of the goods are recorded as unearned revenue, which is a liability on the balance sheet. Revenue and the related cost of sales and gross margin are only recognized for these transactions when the goods are shipped, title passes to the customer and all other revenue recognition criteria are met. The unearned revenue liability is reversed when the revenue is recognized. The related inventory also remains on our balance sheet until these criteria are met. Billings in advance of the shipments allow us to collect cash earlier than billing at the time of the shipment and, therefore, the collected cash can be used to help finance the underlying inventory.

 

Long-term unearned income.  Expenditures for capital equipment to be reimbursed under government contracts are recorded in construction in process. Reimbursements for those expenditures are recorded in unearned income, a liability on the balance sheet. The total cost of the assets to be constructed may include costs reimbursed by the government as well as costs borne by us. When the assets are placed in service and capitalized, this total cost will be depreciated over the useful life of the assets. The unearned income liability will be reduced and credited to income ratably with the annual depreciation expense. This benefit in effect reduces the net expense charged to the income statement to an amount equal to the depreciation on the portion of the cost of the assets borne by us.

 

Capital expenditures subject to reimbursement from the government under the current Title III project and the related unearned income balance totaled $11.5 million as of December 31, 2008. This total could rise to between $60.0 and $70.0 million over the next two to three years depending upon the actual cost of the facility to be constructed, government approval of the project funding, the timing of the construction of the facility and the portion of the cost to be retained by us.

 

Derivatives.  We may use derivative financial instruments to hedge our foreign currency, commodity price and interest rate exposures. We apply hedge accounting when an effective hedge relationship can be documented and maintained. If a hedge is deemed effective, changes in its fair value are recorded in OCI until the underlying hedged item matures. If a hedge does not qualify as effective, changes in its fair value are recorded against income in the current period. We secure derivatives with the intention of hedging existing or forecasted transactions only and do not engage in speculative trading or holding derivatives for investment purposes. Our annual budget, quarterly forecasts and other analyses serve as the basis for determining forecasted transactions. The use of derivatives is

governed by policies established by the Board of Directors. The level of derivatives outstanding may be limited by the availability of credit from financial institutions.

 

Our practice has been to secure hedge contracts denominated in the same manner as the underlying exposure; for example, a yen exposure will only be hedged with a yen contract and not with a surrogate currency. We also secure contracts through financial institutions that are already part of our bank group.

 

During 2006, changes in the pricing of our copper-based products resulted in a reduction of the previously estimated copper price exposure, reducing the need to hedge the exposure with derivative contracts. Therefore, we terminated contracts in 2006 that were initially scheduled to mature in future periods. The deferred gain in OCI on these contracts and other contracts that matured in the second half of 2006 totaled $5.7 million as of December 31, 2006. Gains totaling $0.2 million in 2008 and $5.5 million in 2007 were amortized to cost of sales in accordance with the original maturity schedules in the contracts.

 

See Note H to the Consolidated Financial Statements and the Quantitative and Qualitative Disclosures About Market Risk section below for more information on derivatives.

 

OUTLOOK

 

The reduced consumer spending levels as a result of the global economic crisis and weaker economy have had a significant impact on the level of demand from a number of our markets. Overall, as of year-end 2008, our backlog was down approximately 8% from one year ago. The demand from portions of the telecommunications and computer, automotive electronics, data storage and other key markets was weak as we entered 2009. The demand from the defense and medical markets, however, was strong in early 2009 as these markets do not necessarily move in tandem with general consumer spending levels. We are hopeful that sales into these markets will remain strong for the majority of 2009, although defense sales can be affected by changes in government budgeted spending and appropriation levels. Development work in various markets, including solar energy, offer growth opportunities for us, even in a down economy.

 

Various large customers and demand generators in the key markets that we serve have indicated that they cannot project their level of business in 2009 due to the economic uncertainties. With the weak economic conditions, as of early 2009, we believe that we may generate operating losses early in the year, but that as the economy improves and various new programs and products gain additional acceptance, our sales and profitability should improve over the balance of the year. However, we anticipate that sales and profitability in 2009 will be lower than in 2008.

 

We began making adjustments to our cost structure in the fourth quarter 2008 and we anticipate we will continue to make adjustments in 2009 in order to balance our costs with the current level of business. Headcount was reduced in the fourth quarter 2008 and additional reductions were made and others planned to be made in the first quarter 2009. Other cost control measures have been or will be implemented, including cancellation and delays of various programs and services.

 

Working capital efficiencies, as measured by DSO and inventory turns, slowed down in 2008. Part of this slowdown was due to the sudden softening of the business in the fourth quarter 2008. During 2009, our plan is to adjust inventories to the level of business. We will continue to aggressively collect receivables and monitor and revise our credit terms in order to minimize our credit exposures. We will also continue to monitor the global economic conditions and to evaluate the impact and potential impact on our borrowing capacity or other aspects of our business.

 

Capital spending will also be reduced in 2009 from the 2008 level due to the softer business conditions. Construction of the new primary beryllium facility will continue as planned but other spending will be reduced to roughly the maintenance capital level plus high priority and/or high return projects.

 

 

While the global economic crisis and downturn affected our sales and margins in the fourth quarter 2008 as well as the business levels in the first quarter 2009 and potentially beyond, it has not had a significant impact on our

credit lines, our ability to conduct financial transactions or the valuation of financial instruments as of early in the first quarter 2009. However, this can potentially change quickly as there have been sudden and dramatic changes in the financial standing of a number of firms during this crisis. We have a program in place to closely monitor the credit worthiness and financial condition of our key providers of financial services, including our bank group and insurance carriers, as well as the credit worthiness of customers and vendors and have been developing contingency plans accordingly.

 

Our credit lines are with banks that thus far have remained solvent throughout the crisis. Several of the smaller banks we use for different purposes have been acquired or were in the process of being acquired by other banks as of early in the first quarter 2009, but we do not anticipate these acquisitions will have a material impact on us. Our total borrowing capacity under secured lines that cannot be terminated prior to maturity as long as we continue to meet our debt covenants was in excess of current needs as of December 31, 2008. The availability of credit for foreign currency hedging purposes thus far has been unaffected by the crisis while the available precious metal consignment lines may be reduced slightly going forward due to one institution’s tentative plans to withdraw from the market. We do not have any financial instruments subject to fair value considerations on our December 31, 2008 balance sheet other than the foreign currency derivative financial instruments that hedge our currency exposure in the normal course of business and the investments held by our directors deferred compensation plan trust.

 

The financial statement impact from the risk of one or more of the banks in our bank group becoming insolvent cannot be estimated at the present time.

 

We are exposed to precious metal and commodity price, interest rate and foreign exchange rate differences. While the degree of exposure varies from year to year, our methods and policies designed to manage these exposures have remained fairly consistent. We attempt to minimize the effects of these exposures through the use of natural hedges, which include pricing strategies, borrowings denominated in the same terms as the exposed asset, off-balance sheet arrangements and other methods. Where we cannot use a natural hedge, we may use derivative financial instruments to minimize the effects of these exposures when practical and efficient.

 

We use gold and other precious metals in manufacturing various products. To reduce the exposure to market price changes, precious metals are maintained on a consigned inventory basis. We purchase the metal out of consignment from our suppliers when it is ready to ship to a customer as a finished product. Our purchase price forms the basis for the price charged to the customer for the precious metal content and, therefore, the current cost is matched to the selling price and the price exposure is minimized. The use of precious metal consignment arrangements is governed by a policy approved by the Board of Directors.

 

We are charged a consignment fee by the financial institutions that actually own the precious metals. This fee is partially a function of the market price of the metal. Because of market forces and competition, the fee can only be charged to customers on a case-by-case basis. To further limit price and financing rate exposures, under some circumstances we will require customers to furnish their own metal for processing. This practice is used more frequently when the rates are high and/or more volatile. Customers may also elect to provide their own material for us to process as opposed to purchasing our material. Should the market price of precious metals that we use increase by 20% from the prices on December 31, 2008, the additional pre-tax cost to us on an annual basis would be approximately $0.6 million. This calculation assumes no changes in the quantity of inventory or the underlying fee and that none of the additional fees are charged to customers.

 

The available capacity of our existing credit lines to consign precious metals is a function of the quantity and price of the metals on hand. As prices increase, a given quantity of metal will use a larger proportion of the credit line. A significant prolonged increase in metal prices could result in our credit lines being fully utilized, and, absent securing additional credit line capacity from a financial institution, could require us to purchase precious metals rather than consign them, require customers to supply their own metal and/or force us to turn down additional business opportunities. If we were in a significant precious metal ownership position, we might elect to use derivative financial instruments to hedge the potential price exposure. The financial statement impact of the risk from rising metal prices impacting our credit availability cannot be estimated at the present time.

 

We also use base metals, including copper, in our production processes. When possible, fluctuations in the purchase price of copper are passed on to customers in the form of price adders or reductions. In prior periods, we

entered into derivative contracts to hedge portions of this price exposure and gains on the matured contracts helped to mitigate the negative margin impact of the higher copper prices. There were no copper price derivative contracts outstanding as of December 31, 2008.

 

We use ruthenium in the manufacture of one of our family of products. Ruthenium is not a widely used or traded metal and, therefore, there is no established efficient market for derivative financial instruments that could be used to effectively hedge the ruthenium price exposure. Generally, our pricing practice with respect to ruthenium products is to establish the selling price on our cost to purchase the material, limiting our price exposure. However, the inventory carrying value may be exposed to market fluctuations. The inventory value is maintained at the lower of cost or market and if the market value were to drop below the carrying value, the inventory would have to be reduced accordingly and a charge taken against cost of sales. This risk is mainly associated with sludges and scrap materials, which generally have longer processing times to be refined into a usable form for further manufacturing and are typically not covered by specific sales orders from customers. The market price for ruthenium and other metals fluctuated throughout 2008 and 2007 and, as a result, we recorded lower of cost or market charges totaling $15.2 million in 2008 and $4.5 million in 2007 on portions of our inventory. Assuming no changes to the inventory quantities, costs or make-up and no subsequent sales of the inventory, should the market price of ruthenium decline 20% from the December 31, 2008 price, we would have to record a charge of $0.9 million to write down the exposed portion of the inventory.

 

We are exposed to changes in interest rates on portions of our debt and cash balances. This interest rate exposure is managed by maintaining a combination of short-term and long-term debt and variable and fixed rate instruments. We may also use interest rate swaps to fix the interest rate on variable rate obligations, as we deem appropriate. Excess cash is typically invested in high quality instruments that mature in ninety days or less. Investments are made in compliance with policies approved by the Board of Directors. We did not have any derivatives in place to hedge the interest rate exposure as of December 31, 2008, as the interest rate swap contract that matured in the fourth quarter was not replaced. Assuming no change in amount or make-up of the outstanding debt as of December 31, 2008, a 200 basis point movement upwards in the interest rates would increase our interest expense by $0.8 million.

 

Portions of our international operations sell products priced in foreign currencies, mainly the euro, yen and sterling, while the majority of these products’ costs are incurred in U.S. dollars. We are exposed to currency movements in that if the U.S. dollar strengthens, the translated value of the foreign currency sale and the resulting margin on that sale will be reduced. We typically cannot increase the price of our products for short-term exchange rate movements because of local competition. To minimize this exposure, we may purchase foreign currency forward contracts, options and collars in compliance with approved policies. Should the dollar strengthen, the decline in the translated value of the margins should be offset by a gain on the hedge contract. A decrease in the value of the dollar would result in larger margins but potentially a loss on the contract, depending upon the method used to hedge the exposure.

 

The notional value of the outstanding currency contracts was $47.4 million as of December 31, 2008. If the dollar weakened 10% against the currencies we have hedged from the December 31, 2008 exchange rates, the reduced gain and/or increased loss on the outstanding contracts as of December 31, 2008 would reduce pre-tax profits by approximately $4.5 million in 2009. This calculation does not take into account the increase in margins as a result of translating foreign currency sales at the more favorable exchange rates, any changes in margins from potential volume fluctuations caused by currency movements or the translation effects on any other foreign currency denominated income statement or balance sheet item.

 

The fair values of derivatives, which are determined under the guidelines of Statement No. 157, “Fair Value Measurements”, are recorded on the balance sheet as assets or liabilities. The fair value of the outstanding foreign currency contracts was a net liability of $1.2 million at December 31, 2008, indicating that the average hedge rates were unfavorable compared to the actual year-end market exchange rates.

 

 

 

The management of Brush Engineered Materials Inc. and subsidiaries is responsible for establishing and maintaining adequate internal controls over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Brush Engineered Materials Inc. and subsidiaries’ internal control system was designed to provide reasonable assurance to the Company’s management and Board of Directors regarding the preparation and fair presentation of published financial statements. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

 

Brush Engineered Materials Inc. and subsidiaries’ management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2008. In making this assessment, it used the framework set forth by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria) in Internal Control-Integrated Framework. Based on our assessment, we believe that, as of December 31, 2008, the Company’s internal control over financial reporting is effective.

 

The effectiveness of our internal control over financial reporting as of December 31, 2008 has been audited by Ernst & Young LLP, an independent registered public accounting firm, as stated in their report herein.

 

Richard J. Hipple

Chairman, President and Chief Executive Officer

 

John D. Grampa

Senior Vice President Finance and Chief Financial Officer

 

The Board of Directors and Shareholders of Brush Engineered Materials Inc.

 

We have audited Brush Engineered Material Inc.’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Brush Engineered Material Inc.’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

In our opinion, Brush Engineered Materials Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on the COSO criteria.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets as of December 31, 2008 and 2007, and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2008 of Brush Engineered Materials Inc. and subsidiaries and our report dated February 25, 2009 expressed an unqualified opinion thereon.

 

 

Cleveland, Ohio

February 25, 2009

Report of Independent Registered Public Accounting Firm

 

The Board of Directors and Shareholders of Brush Engineered Materials Inc.

 

We have audited the accompanying consolidated balance sheets of Brush Engineered Materials Inc. and subsidiaries as of December 31, 2008 and 2007, and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2008. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Brush Engineered Materials Inc. and subsidiaries at December 31, 2008 and 2007, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2008, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

 

As discussed in Note I to the financial statements, effective December 31, 2006, the Company adopted Statement of Financial Accounting Standards No. 158, Employers’ Accounting for Defined Benefit Pensions and Other Postretirement Plans. Also, as discussed in Notes A and P to the financial statements, the Company adopted Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement No. 109, effective January 1, 2007.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Brush Engineered Materials Inc.’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 25, 2009 expressed an unqualified opinion thereon.

 

 

Cleveland, Ohio

February 25, 2009

Brush Engineered Materials Inc. and Subsidiaries
Years ended December 31, 2008, 2007 and 2006

Consolidated Statements of Income

 

 

See Notes to Consolidated Financial Statements.

Brush Engineered Materials Inc. and Subsidiaries
Years ended December 31, 2008, 2007 and 2006

Consolidated Statements of Cash Flows

 

 

See Notes to Consolidated Financial Statements.

Brush Engineered Materials Inc. and Subsidiaries
December 31, 2008 and 2007

Consolidated Balance Sheets